AEC 810, INSTITUTIONAL AND BEHAVIORAL ECONOMICS
Class Session:
| 7 | 13 | 19 | 25 | |
| 2 | 8 | 14 | 20 | 26 |
| 3 | 9 | 15 | 21 | 27 |
| 4 | 10 | 16 | 22 | 28 |
| 5 | 11 | 17 | 23 | 29 |
| 6 | 12 | 18 | 24 | 30 |
2. PROPERTY AS POWER, ECONOMIZING, and KNOWLEDGE. (Institutions as constraints and as enabling. How paradigms affect what you see, and what you question. )
Perhaps the first thing to do in this course is not to begin reading, but to reflect upon your own experience. You have had a lot of economics by now. How well can you explain the main economic phenomena in the world of interest to you? Make some notes on where you feel confident and where you see holes. Have you observed differences in economic performance of different countries, etc.? Are they related to differences in institutions?
You have some responsibility for asking questions of this material, but I will help. What are the big questions? The task of analysis can be seen as designing institutions (rights) so that total wealth is maximized. Wealth potential can be seen as independent of institutional choice and the job of the latter is only to realize its potential, i.e. to economize (Eggertsson). Alternatively, preferences can be seen as being learned and shaped by institutions so that what constitutes wealth is being worked out continuously. Same for technology. Further, wealth can be seen as dependent on institutional choice and the job of the latter is to determine whose choices count when choices conflict, i.e. to settle issues of power. Can ownership affect demand? Is collective action wealth defining and enabling or just damnable conspiracy (rent seeking)?
Institutional economics embraces three levels of analysis: economizing, power, and knowledge. Economizing asks which institution is more efficient. Power analysis asks whose preferences count in economizing. Who has what to trade. Which institution is efficient to whose purposes? Knowledge analysis asks how preferences and purposes are formed and how technology and institutions change.
A. C&C. "Introduction" It is an attempt to specify the essential concepts. It is the whole course in one easy lesson! The rest of the course will elaborate it (and probably change it with your help).
Here are some key concepts that will be used throughout the course:
C&C sets an immodest goal: to develop theory useful to do both impact and change analysis and useful to understand both formal and informal institutions.
Levels of Analysis:
Paradigm Fundamentals:
Structural Alternatives:
Alternative Perspectives: Ways to Frame Questions:
B. Most of you have already extensively studied neo-classical economics and are familiar with what Eggertsson calls "the essential elements of the economic approach--stable preferences, the rational-choice model, and equilibrium" which may be contrasted to C&C. He and Coase say the old institutionalists had no theory (p.10). You must decide. What do you want theory to do? Is it useful if not deterministic? If not about economizing.? He wants to evaluate institutional alternatives with criteria of value and wealth (p.12). But what if institutions affect value (the Value Circularity Problem)?
C. Rutherford gives a quick overview which contrasts the old institutionalists who broke with neoclassical economics and the new institutionalists whose innovations still keep some of the neoclassical elements (economizing). Rutherford (p.174) offers the following dichotomies and then suggests that there is a lot of variation in practitioners within each tradition and that the dichotomies really identify fundamental problems whose solution probably requires some mix of the elements.
1. Role of formal theoretical models vs. historical and literary approaches.
2. The effect of individuals on institutions (economizing in the choice of institutions) vs. effect of institutions on individuals.
3. Rationalist vs. limits to rationality.
4. Institutions as a result of spontaneous vs. deliberate change.
5. Determinist welfare economics indicating what is uniquely efficient and productive vs. working out of normative judgments (settlement of conflict). This leads to different views on the appropriate role of government. In developing your own view consider his conclusion that "economic efficiency or social benefit becomes uncomfortably difficult to define (p.6)."
D. Bowles prologue: "With all the terms of a transaction contractually specified, nothing is left for the exercise of power to be about." 10 Is this true?
Review Questions: Some questions to ask yourself after reading to see if you understand:
1. Always ask yourself after reading the material, "what is the big point?" What difference does it make if you inquire of efficiency, power, or knowledge?
2. Can freedom be a general goal for all and a criterion to judge alternative institutions? Evaluate this proposition: "I seek no power, I just want to be left alone."
3. Is any economy unplanned?
4. Can value maximization (efficiency) be a criteria to judge alternative institutions?
Some additional notes and observations:
1. Why are some people (countries) rich and others poor? What is the role of property and power vis a vis explanations from human capital theory, inefficient institutions, or differences in laziness or achievement motivations? Later we will be reading Williamson and North who argue that economic growth is made possible by institutions that lower transaction costs such that impersonal trade can take advantage of specialization and economies of scale. From this efficiency (economizing) view, every one gains. Williamson and North try hard to avoid issues of power in explaining institutions or alternative paths of development. Why does North (or Eggertsson) conceive of institutions as constraints? His is not a conception that nature plus free market (absence of constraints) is the best of all worlds. Institutions are needed to reduce uncertainty concerning the promises of others. Still this leaves the question of how people learned their preferences largely unexamined, as well as the C&C question about power--who has what to efficiently trade. Let's try to sort out the strengths of these several approaches.
2. How does pure competition limit the use of power? What sources of power are not controlled by achieving competition? Is it true that as long as there are many buyers and sellers, it makes no difference whether you are rich or poor since no one can influence price?
3. This is a course in economic theory in the same sense as a micro or macro theory course, i.e. it is a guide to the specification of models of the economy (relevant variables and hypothesized relationships among them). Contrast institutional impact and change theory as well as the normative propositions of welfare economics.
a. Welfare economics theory: This theory tries to provide a scientific guide to the question, which institution, right or rules is better (optimal or whatever)? The concept of externality is central to the question. The following from Rowley and Peacock (1975, p. 31) appears at first to be an innocent definition, but is typical of welfare economics theory which suggests policy if you prize efficiency. "Externalities arise whenever economic activity on the part of one individual (in consumption or in production) generates an effect (beneficial or detrimental) on some other individual who is not party to the activity." (or not properly accounted for). What is the intended policy implications of "who is not a party to the activity?" Is externality then a special and unusual case or just another definition of scarcity? The Rowley approach is in contrast to that of C&C, 5.5.2 and PPPC, Ch. 11. This course is not primarily an exercise in welfare economics, but its framework is useful for a critique thereof, which is done explicitly in Periods 20 & 21. The theory of C&C is useful in raising the level of policy debate (clarifying the issues at conflict among people). Samuels' Chapter 3 in Law and Economics makes the point if you need additional references.
b. Theories of Institutional Change (Evolution): How did institutions evolve in the past and where are they going? What can we do with such knowledge other than satisfy our curiosity? There are desired outcomes that can not be achieved by changing the relative cost of alternative behaviors. Only if people's preferences and cognitions change can we get some performances. We often choose a certain rule to achieve a certain performance in the short run and later discover that it started us down a path we don't like. Learning is essential to any theory of institutional evolution. Preferences and technology change. These changes are the focus of several of our class periods including: 6. Behavioral concepts; 11. Evolution; 17, The economic development themes of North; 27. Technology; and 29. New Institutional Alternatives.
c. Impact Analysis: This theory is concerned with predicting the substantive performance of an alternative proposed institution and not with predicting what institutions are coming next. There are a number of similarities in the theoretical constructs being employed in the institutional economics literature: The transaction as the unit of analysis and emphasis on the relation among people rather than commodities of the production function; Utilization of a situation, structure (institutions), behavior, performance paradigm. While recognizing the need for simplification in theory building, we will try not to make grossly counterfactual assumptions especially about human behavior.
4. Detail matters: Try applying this idea to current events. Jeffery Sachs goes to Poland and advocates cold turkey markets everywhere. He doesn't bother with any history, traditions, agency and firm capacities, specific rules and their enforcement by courts, etc. Will the "right" big policy direction with poor details perform as well as an inferior big policy direction with sensible details? Williamson emphasizes comparative institutional analysis of actual sets of institutions rather than imaginary what-almost-could-be institutions.
Bounded rationality applies to researchers as well as economic participants: The same learning capacity that permits creativity is also the source of uncertainty with respect to our own and others' behavior. How does your paradigm deal with that fact?
5. To develop an economic theory of the state is one way to characterize part of our task. Warren Samuels in Fundamentals of the Economic Role of Government writes, "(1) Government is deeply involved in the definition and in the creation of the economy. (2) Efforts are continually being made to obfuscate the role of government in defining and creating the economy so as to selectively channel both the definition and the (re)creation -- efforts which are willy-nilly a part of the process of definition and (re)creation itself. (3) The proximate critical matter is almost always the legal change of law, that is, the change by law of the interests to which government is to give its support: Government is inexorably involved in the status quo, and the question is the change of the details of that involvement. (4) Although the economy and polity are typically comprehended as essentially self-subsistent and independent -- albeit interacting -- spheres or processes, there is a "legal economic nexus" in which both originate in an ongoing manner."
ETC.
From time to time, I will append some further bits at the end of these study notes in a section labeled ETC. They may be ignored as far as assignments are concerned. They may be of use in the future as you return to some of these topics and perhaps want to do further reading--there is so much good stuff. I was sorely tempted to assign some bibliographic entries for a number of institutional economists that I find particularly stimulating as a way to introduce you to the field. They are available in A Biographical Dictionary of Dissenting Economists, ed. Philip Arestis and Malcolm Sawyer, Elgar, 1992. Some are written by the scholars themselves and provide a glimpse of their personalities. Another source is New Horizons in Economic Thought, ed. Warren Samuels, Elgar, 1992, with entries for such as Akerlof, Elster, Hirschman, Leibenstein, North, and Sen among others. And Samuels, ed., again, American Economists of the Late Twentieth Century, Elgar, 1996, including Bowles, Gintis, Frank, Heilbronner, Kahneman, Nelson, Olson, Schelling, and Solo.
3. POWER, COST, AND THE POLITICAL ECONOMY
---Cost as a function of institutions. Demand as a function of income distribution.
A. C&C-- What qualifies as theory?
B. Samuels--"Whose interests count" is a question about power (1561). Whose interests are to be afforded the status of property? It is tempting to answer, "Those that have merit (are efficient)." What does Samuels means when he says the answer has to be worked out?
Efficiency is derived from rights, not determinative thereof (1563).
Some key concepts: Dual nature of rights, reciprocal character of externalities, and ubiquity of externalities (1564). Are externalities a special case? What is the problem with the usual textbook definition? What is the difference between a spillover and an ordinary production input? (Answer)
Try drawing a figure illustrating the institutional dimensions of the typical optimal allocation of resources following the suggestions of pp. 1565-66. Can you see how power is involved in each dimension?
What can non-intervention of government mean as a guide to policy? Can absence of power be obtained? What does it mean to say that institutions are chosen because they are efficient and not because of power?
Samuels posits some tensions:
Are you convinced by the "inexorable necessity of choice by government when private interests conflict?" (1577) i.e. power in use and as a result?
Wish we had time for Steve Keen, Debunking Economics, who argues that the intersection of supply and demand can't be used to explain prices pp. 39-47. He argues that income distribution and prices (content of GNP) are not independent. Pages 67-8 show that supply and demand are interdependent. Things that alter supply (factor payments) will also alter demand (when factor owners spend). Pages 72-77 further demonstrate that supply and demand are interdependent when there are economies of scale (a future topic). Cost of production (and product prices) depend on the imagined target output (scale). This target is a social construct, i.e. an institution. Chapter 5 is about why productivity doesn't determine wages. The summary p. 126 suggests that if wages are not determined by MVP tied to the production function, there is room for power (institutions?). Keen does not discuss here the problem of measuring marginal products when complements (including teams) are involved. the intersection of supply and demand. Keen has a website with more perspective on his message http://www.debnking-economics.com
A short article length summary of the above is Frederic Lee and Steve Keen, ""The Incoherent Emperor: A Heterodox Critique of Neoclassical Microeconomic Theory," Review of Social Economy, June 2004. Available on line at MSU Library, electronic resources, journals.
Some other definitions of power:
Review Questions:
4. BEHAVIORAL CONCEPTS: LEARNING, REINFORCEMENT AND COGNITION -- How the brain works.
. Behavioral economics requires a paradigm and it is reasonable to look for concepts in the field of psychology. If we had time we would look much more into psychology, especially into social and industrial psychology.
A. C&C introduces a host of ideas. Especially important is Section 5 on learning. There you will find an introduction to the behaviorism of Skinner. Skinner is radical in that he believes behavior is shaped by feedback from the environment and not by inner mental states (such as fixed preferences). Thus he is little interested in psychiatry which aims at mental states of self knowledge. He, like many economists, dispairs of measureing mental states and does not trust what people say. Skinner would say you can't change behavior by understanding the past--you have to arrange some new reinforcers in the environment. Journal File. Behaviorism is not now in fashion in psychology. Skinner went too far, mental states do matter, but he was right about reinforcers. What are the implications for economics? The all too typical approach to changing behavior is to increase the penalty for unwanted behavior--increasing jail sentances is an example. This assumes people are calculating future benefits and costs. Skinner instead would try to reward present desired behavior and let the subconscious work. See what you can draw from the reading for your own framework of analysis and policy area.
Skinner's radical behaviorism is essentially a theory of learning. It differs "radically" from classical conditioning of behavior and response. Skinner says, "stimuli do not elicit operant responses; they simply modify the probability that responses will be emitted. They do so because of the contingencies of reinforcement in which they have played a part, and they may act in combination with other conditions, possibly but not necessarily to the point at which a response occurs. This is a far different role from that of the eliciting stimulus in a reflex." (Skinner, About Behaviorism, p. 222). Remember that Skinner's model is stimulus, behavior, reinforcment and back again.
How do the readings influence your ideology, especially in respect to the proper role of government and the universal issue of social control? Do you believe it is possible to design a better culture? Or, shall we just blame people for their moral failings and lack of will?
There are three possible views of hedonism--that behavior is "motivated" by anticipated pleasure-pain in the future, in the present, and in the past. The rational choice paradigm assumes hedonism of the future--i.e., maximizing the expected value or utility (reasoning why). The reinforcement theories of psychology--including Skinner--emphasize a hedonism of the past (knowing that) . Pleasure-pain are important, but they are important because they are involved in the process of shaping behavior through reinforcement not as the motivation of behavior. Note that pleasure and pain as usually used are not the same as positive and negative reinforcement. What difference does it make for policy analysis which view is held? How do they relate to the utility of satisficing vs. maximizing models of behavior for economic analysis?
. How do you react to and incorporate the following observations and questions into your framework of analysis?
For more on Skinner, see, Robert Nye, The Legacy of B.F. Skinner, on reserve, main library.), Also see, John Platt, "Beyond Freedom and Dignity," Center Magazine, 5(2):34-52 (1972); A. Charles Catania and Stevan Harnad, eds., The Selection of Behavior, Cambridge Univ. Press, 1988.
B. Margolis (optional) on pattern recognition: It is difficult to find readings that summarize what behavioral science has to offer. I recommend reading the entire Margolis book (someday), but for now I give you C&C, section 3.5.2 plus my journal notes and excerpts. Margolis is an economist, but does not aim this book at economics, so you will have to do the extension.
1. As you work with these ideas it is important to practice using them in dealing with standard analysis in economics. For the class discussion be specifically prepared to show what you conclude are the implications of learning (reinforcement) and pattern recognition for doing demand analysis i.e. "knowing that." After you have worked it out for yourself, see my Journal Note.
2. In the real world of empirical data, observations are often made of a positive relationship between price and quantity sold. List as many hypotheses as you can which might be explanations of such a phenomenon.
C. The split brain observations of Gazzaniga (optional) help me organize a lot of my own observations. I am impressed by our need to rationalize and explain even when there is no explanation. Then the explanation becomes part of our experienced reality.
Our brain's practice of rationalization may give observers the impression that behavior was chosen by relating alternative means to prior ends when in fact there was no such process undertaken. We may also be quite calculating with respect to a limited set of means while seldom being aware of why the set is as it is.
My view of rationality is shaped by John Dewey's conception of mostly habitual behavior punctuated by occasional interruptions at which time both means and ends are considered. Occasionally the interruptions may be one of introspection and conceptualizing ideals (and thus gaps with perceived reality) but more commonly it is stimulated by the environment. Observation of multiple brain levels gives new perspective to the theory of revealed preferences and the doctrine that "People have their reasons." Perhaps economics should give less attention to rational behavior and more to the activity of rationalization.
Our main interest here is not to ask if people are rational or not, but rather how can we use knowledge of behavioral regularities in business or to design economic institutions.
Review Questions
1. What does public policy look like that is built on "reasoning why" Vs. "knowing that?"
2. How can Skinner's categories of reinforcers be put into economic terms? My journal file.
3. What are the implications of Skinner for demand analysis? My journal file.
4. What are the implications of behavioral regularities for contingent valuation? My journal file.
5. Why does the mind's demand for reasons explain the persistance of standard consumer theory in the face of evidence of its failures?
6. Keeping cues and behavioral regularities in mind, think about how institutions are frames affecting behavior by providing one anchor or another, remind us of opportunity cost (availability), what items go into what mental accounts, whether something gets coded as gain or loss, and whether unconscious emotive content gets attached.
7. Many behaviorial regularities might be regarded as the response to bounded rationality. We employ decision heuristics to conserve mental energy. One of these heuristics is lexicographic choice described by Peter Earl (C&C p. 29). What are the policy implications?
8. The Allais Paradox (C&C p. 44): The source of the paradox is the psychology of regret and embarrassment. Is it related to our dislike of looking dumb at all costs--i.e. the student who won't risk a question or comment for fear of looking dumb even if it results in remaining dumb? It also seems related to whether something is coded as a gain or loss (C&C p.42). A question which proves embarrassing is not just a no-gain returning to the original level of utility, but a loss.
The brain is a chemical-electrical organism. Its workings can be seen in images generated by PET scans and MRI's. A readable current account is Steven Johnson, Mind Wide Open: Your Brain and theNeuroscience of Everyday Life, New York: Scribner, 2004. This research confirms the modularity of the brain and the role of unconscious processes.
* If you write a paper today, apply the readings to alternative ways that behavior might be changed in a specific area, e.g. savings, pollution, food consumption, etc.
A. Elster might create some emotion in some readers. Are emotions the enemy of the rational thought that economics assumes? Elster finds that the emotions are economical. As part of our continuing theme of bounded rationality, emotions help to sort out and simplify complex decisions by focusing our attention on a few salient features. Is a preference (a valuation) an emotion?
Think about the fact that people get angry at non-cooperators and at poor service. What is the role of guilt? What are the implications of cognitive dissonance for preference stability? The hormone oxytocin is associated with human bonding.
Disappointment, regret, and shame are not just more preferences to be traded off with other goods. Rather they set in moton a selective search for vindication and justification (recall Gazzaniga). We create reasons, not just tradeoff prior reasons. Elster has a place for non-intentional psychic casuality as well as deliberate choice (65).
We remember the details of stressful events much more than the non-stressful. Stress events leave a chemical connection that is resistant to erosion and can trigger unconcsious reaction to a similar stimulous. This sered us well in avoiding danger on the African savanna. What is the impl;ication for economics?
Economists would do well to heed Elster's pithy summary, individuals frequently "do not know what they want; or do not know what they know; or fail to do what they have decided to do" (181, Solomonic Judgements). Or, am I the only one who has these behaviors?
B. Browse enough of Bowles to get a sense of how his selection of psychological concepts differs from that of C&C. Economists are comfortable with the notion of preferences and his chapter goes there. He wants to add some arguments to the self-interest of the typical utility function-- altruism, spite, fair-mindedness, and reciprocity (120). This makes calculation even more difficult if there is bounded rationality. He says, "the objective of a reformulation of the behavioral foundations of economics should not be some new Homo sociologicus [heaven forbid!] to replace Homo economicus, but a framework capable of taking account of heterogeneity (123)." Think about his deep statement, "If prefferences are to explain behaviors, they cannot unassisted also do the work of evalluating outcomes (125)f."
Review Questions:
1. What does your list of key behavioral concepts look like? See my journal file check list of the readings in the last two periods.
2. Review exercise # 1--(and clue to what your short papers might contain):
Once that we admit that the connection between environment and cognition is not mechanistic, we can find lots of applications in economics. Economists have a lot of data relating quantity of a named good to price. Some assume that we carry indifference maps in our heads with all possible goods neatly categorized with names and features. But, we can not. Rather the categories are a matter of perception at the moment. What are called "mental models" are models of how the brain actually works given its limited information processing capacity. The problem is clear for contingent valuation (and hedonics) because the willingness to pay question must describe the good to be valued. Economists seem to avoid the problem when they assemble market prices for #1 corn, cars, and TV's, or do they? Would the consumer describe the product in the same way? We can't predict citizens' evaluation of the seriousness of an environmental hazard if we can't say a new hazard is like an old one. Sellers of market products are trying to understand consumer perception, eg. they don't sell cars, but power, sex, life-styles, etc. Rather than trying to get the consumer to consider all possible dimensions that experts might understand, the seller emphasizes those dimensions that the seller expects her product to look good with.
3. Review Exercise # 2. You could practice applying behavior concepts to increase the policy options (and to understand their impact) in a field such a flood insurance.
Kunreuther and Slovic "Economics, Psychology and Protective Behavior," Amer. Economic Review, May, 1978, 68:64-69 (on reserve, Main Library), provide a public policy application of some of our concepts. They start with an empirical observation that people don't buy flood (or crop) insurance that appears economically advantageous. "People preferred to insure against relatively high-probability, low loss hazards and tended to reject insurance in situations where the probability of loss was low and the potential losses were high." They explain this behavior in terms of bounded rationality--limitations on people's time ("finite reservoir of concern"). We can't worry about everything. It might also be explained in terms of the dominance of recent information over priors (it's dry now isn't it?). So what are implications for policy?
l. Alter the frame for decisions: In conducting education, express the probability of disaster in terms of frequency in 25 years (.22) instead of in 100 years (.01). Mathematically it is the same, but not psychologically as indicated by their experiments.
2. General education: Try to put people into their controller logical side of the brain so they are aware of long run economics. Appointed controllers may be able to do this for any given program, but we don't have the resources for every area that needs this. When we urge people to calculate a certain set of decisions we should be aware that other sets must be given over to other processes.
3. Mandatory coverage (super-ordinate authority): An extension of the above theme is that while in their controller brain, people demand public officials to require behavior that they would do themselves if they could be in their controller brain all the time. It is like Elster's metaphor of Ulysses tieing himself to the mast. The problem here is that people often resent the particular application and regard government as a paternalistic heavy handed big brother.
4. Change pattern of reinforcers in another related commodity: Skinner emphasizes that we learn patterns of behavior based on experience (where we learned it may not be evident). Skinner would explain the purchase of insurance for high probability-low loss events by saying that the behavior of paying premiums is reinforced by getting a claim check intermittently, while the long run economics can only exist in the calculating mind. It is hard to imagine how to change this in the context of flood insurance. But perhaps the reinforcers can be changed in related experiences. I can't think of something that fits here (can you?), but let me demonstrate the idea. Suppose we are interested in decreasing opportunistic behaviors like littering or not contributing to public television. Another area of giving, altruistic behavior (not individually advantageous) is in blood. In the U.S., blood is paid for and given free. If we passed a law prohibiting commercial sales, it would make the value of donated blood higher. Donors would feel better about their gift if the recipient had no alternative. In Skinnerian terms, this reinforcer might increase the probability of more blood being donated. And it might also increase the probability of other behaviors which are coded as similar to blood. (Skinner refers to this as "stimulus generalization' and Margolis as "pattern cues.") The point is that commodity policies can't be evaluated in a vacuum. In evaluating a volunteer vs. paid professional fire or ambulance services, don't just ask which controls fires the cheapest or best, but which increases the probability of related behaviors which are in short supply. Human behaviors in other areas are the product of any given public policy applied to a particular commodity. The character of people is the result of public policy as well as the goods produced. Or as Skinner might ask, how do people learn to want to do what they need to do in a good society? See. "Hurricane Evacuation, Learning and Reasons," Schmid, Journal File, 1999.
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Economic analysis requires propositions about human behavior. Why do we make assumptions rather than utilize observation? We inquire a lot about the physical production function and could inquire about the brain function that converts cognitive inputs from the environment into behavioral output. The assigned reading addresses the latter with papers by three Nobel prize winners.
A. "Rationality is not a property of the individual alone," says Arrow. It has a social context. A person to be rational must understand the rationality of others who are part of her environment. Equilibrium is hard to conceptualize in this context. If other people have different tastes and skills it is hard for a person to be rational w/o some institutions to regularize behavior. He agrees with Simon that in the aggregate the hypothesis of rational behavior has no implications (S388) but requires auxiliary assumptions. Difficult to find a rationality model that explains savings, wealth, and bequest data. "A demand curve is more complex than a price. It involves knowing about the behavior of others." 391. Note the rap on Coase, another Nobel laureate, p. S392, with profound implications for Eastern Europe.
B. Simon points to a class of important policy problems whose design turns on whether people make substitutions to try to maintain some condition. For example, if the public offers a compensatory education program, do parents reallocate their resources so that the child's future income is unaffected. Simon p. S213 says that contrary to the argument of Becker, utility maximization does not tell us what parents will do. The issue is how they conceive of their utility. (This suggests that we should inquire what is in the utility function rather than whether it is maximized.) Even speaking of behavior in reference to a utility function implies more consciousness than is often present.
Simon also says it is central whether luck and endowment are additive or multiplicative. I am not sure how this works. Is it a problem for the parent to know how much parental resources to withdraw to keep the child's income constant? This introduces an uncertainty and cognitive problem to the decision other than the parent's utility function. How then can we test whether the parent has a given utility function or whether parental actions are explained by their perception of the luck-endowment production function?
What other policy areas have this same pattern? What is your prediction of the effect of income transfers on the amount of work by low income people? Do people substitute free income for work and hold their utility constant? Simon's point seems to be that these are factual questions to be measured and not inferred from some model of optimization.
When relative prices change, there are opportunities to maintain or increase utility. If people respond, what shall we infer about rationality (maximization)? Becker says that when women's wages increased, the opportunity cost of children increased and women had fewer children and worked outside the home more thus indicating utility maximization. Simon offers other possible changes that could explain the same behavior including a change in the utility function. Why are stable preferences so important to Becker?
If preferences are relatively constant, then there is no reason to study their formation. They are, like mountains, just there. The only issue then is efficiency of means.
Does Simon mean by "procedural" not a degree of consciousness, but whether ends and means are constantly chosen, formed (evolved) in the same cognitive crucible (shall we say bucket of worms)? Analysts can't ask if people maximize, if what is being maximized is in the process (procedural) of being formed. One sense of procedural that Simon uses is that people try to compare alternatives as best they can and thus may fall short of the substance that some more omniscient observer might achieve. But the concept of a moving target is more fundamentally procedural than mere information problems imply. For those familiar with pragmatic philosophy, there are some interesting parallels.
Simon's reference to voting allows you to use your own experience. I doubt if the advisors to the candidates are particularly concerned with whether people are maximizing self interest or not. The big question that Simon suggests is whether the median voter has inflation, jobs, debt, or the flag on the agenda (i.e. how do they define their self).
C. Sen argues for a concept of meta-preferences. Sen distinguishes between commitment and sympathy. Commitment is a sense of obligation and doing the right thing even if it brings costs to the actor and even if the person does not feel close to the beneficiary of the act. Sympathy is a sense of identification with others so that their welfare affects yours (what Boulding calls benevolence).
There is an analytic problem in recognizing the appropriate boundary to evaluate a sequence of choices. Sen says, "our love of variety makes it illegitimate to consider individual acts of choice as the proper units (rather than sequences of choices) while, on the other hand, a lapse of time makes it difficult to distinguish between inconsistencies and changing tastes." This is relevant to Frank's (and Elster) discussion of apparent irrational acts which cut off current options in order to achieve some long run objective. This is the myth of Ulysses tieing himself to the mast so as not to succumb to the attractive sirens ending in ship wreck. (For additional reading on behavior involving a sequence of choices, see Hernstein.)
For Sen's Nobel citation see, http://www.almaz.com/nobel/nobel.html
Review Questons
1. How would you explain the fact that environmental regulation often leads firms to discover profitable ways to recycle? Check your answer with my Journal File.
2. Is the point of bounded rationality that people would choose differently if they had more information? Can the theory of full rationality be saved by postulating a preference for cooperation, voting, or altruism? Check your answer with my Journal File.
3. For a critique of behavioral economics, see Edward Glaeser, "Psychology and the Market," AER, May, 2004, 408-13. This is an attack on Kahneman whose Nobel lecture summarizes his findings--"Maps of Bounded Rationality: Psychology for Behavioral Economics," AER, Dec, 2003, 1449-75. I never thought Kahneman believed that a critique of the rational choice model was an argument for government and paternalism, but Glaeser seems to think so. Mullainathan and Thaler's paper "Behavioral Economics" anticipates Glaeser's critique. Perhaps the emphasis in Kahneman's experimental research on mistaken estimates of objectivly knowable numbers misses the point that different frames produce different choices where there is no prior truth. There is no such thing as my true preferences that different frames may distort. All my preferences have some frame and evolve as I learn. What do you think?
7. DOMAIN OF INSTITUTIONAL ANALYSIS
----Open systems and the interdependence of the individual and society.
Begin by reflecting on your ability to explain economic phenomena of interest to you. Supposedly, economic theories compete and survive according to their ability to explain and predict. Before we get into the pieces of analysis, it would be useful to get some perspective on our domain of analysis.
A.C&C: What does it mean to say "Neither individuals nor institutions are a starting place for analysis. Both are an outcome of a process?" C&C (69-70) says institutions are not factors of production. Neo-classical economists never thought so and some insitutionalists may be offended. What will Schmid do for friends? Power vs. economizing theories is a fundamental distinction. Do you see what difference it makes? Why distinguish organizations and institutions? Part of chapter 5 is a review of previous readings by Samuels and Schmid on cost and Samuels on the cedar rust case (81). Why specify performance in substantive terms? Why are efficiency, freedom, democracy, and cost minimization poor performance variables?
B. Hodgson drives immediately to link institutions and cognition. He refuses to work with the isolated individual as the unit of analysis, but rather insists that while perception is subjective, its structure is a social phenomena. He suggests that "habit" be the focus of institutional analysis. Surely informal institutions are important, but their substitutability and complementarity with formal legal institutions must be analyzed. If you reflect back to authors like Samuels and the legal-economic nexus, you see an emphasis on formal institutions. Some institutionalists follow John R. Commons who focused on legal institutions while others like Hodgson follow Thorstein Veblen's emphasis on informal culture. Good theory must account for both since they are substitutes and complements.
Some passages I underlined:
C. Ruminations on Potts (optional): for Schmid's review of Potts, see potts.htm
1. "Information acting upon itself." Economy = a complex system capable of tranforming itself by reconfiguring information. What can this mean?
2. Shift attention from "general allocation of resource problem" to general coordination problem."
3. "Connections define information. Are institutions connectors? Connections define dynamic properties of a system.
4. What is the economy made of? A relationship of things? A relationship of people described as contracts, forms of organization, and decision rules-- all processing information. Information is the stuff of coordinatin. Is it a thing, or a relationship among things?
5. Densely connected systems are chaotic. Sparsely connecting systems are frozen.
6. What does Potts mean by "self-organizing?" Automatic, natural, tending toward optimization??
7. What is a "real field?" All elements connected. "Field theory does not apply generally to the domain of economic agent interactions (13)." Do heterodox critiques of neo-classical econmics boil down to a rejection of field theory?
8. Economies have some unconnected elements and their dynamics consist of evolving disconnections and new connections."Choice" must refer to making connections, not optimizing calculation involving technology and utility functions.
9. This is highly abstract stuff. How can you use it? One implication is that efficiency is not a single thing--rather it is a derivative of starting place property rights distribution (The particular "connection"/"economic space" of people with authority to act without consent of others who can only offer bids for relief). How is this related to the idea that institutions are not factors of production?
10. "There are no markets in neoclassical theory, only supply and demand functions (23)." How do you picture real markets? Remember our difficulty with the Russell painting of the cowboy and Indian.
11. What is the implication of the fact that there are 45,000 items in a typical supermarket?
12. Fitness is always local, not global. "Selection does not optimize but is irreducibly a historically contingent process (35)." It is institutions that determine whch of many ossible locales are operative.
13. Lawson--"society is constituted in large part by a set of positions, each associated with numerous oblilgations, rights and duties and into which agents, as it were, slot (39)." What does the world look like when seen as a network of positions characterized by rules which are at one time given to the actors and capable of being transformed (change in connections) at another time. Is this doublespeak?
14."The geometry of economic space is not integral." Then what is it? A changing network of selected human connections? Aren't you glad that is now clear?!!
D. Herbert Simon (optional) has a substantial reputation in economics and behavioral science, including the Nobel Prize. He has emphasized the importance of understanding behavior of economic actors and organizations in contrast to assuming it. Simon has emphasized the importance of bounded rationality and satisficing behavior. In this interview he raises some serious questions about the way economists develop and use theory. How do you react to the general thrust of his argument? What difference does it make?
1. What is the role of the assumption of utility maximization in economic analysis? In discussing work by Gary Becker, which is based on the utility maximization assumption, Simon comments "In this example, the assumption that women maximize utility in making their decisions is neither necessary nor sufficient to make the conclusions that Becker reaches." (page 20) He implies that this is generally the case and that it is additional assumptions about the situation or behavior which lead to the conclusions. But if we get out of our armchairs, we will have to talk to people, and we all know you can't trust what people say. Prices on the other hand are easily observable.What can we learn by asking former housewives why they entered the workforce?
2. Simon argues for the testing of economic theory against the empirical evidence. He is not much impressed with the idea that deduction from a set of clearly counter factual assumptions is likely to lead to useful conclusions. He says "But I don't know of any other science that purports to be talking about real world phenomena, where statements are regularly made that are blatantly contrary to fact (23)." Simon seems to be calling for a new empirically based micro economics. Do you believe the situation is as bad as implied by Simon? What is the role of theory in policy analysis and how does it relate to the roles of economists?
His example of flood insurance behavior is not a description of calculated "good enough" search behavior, but rather a description of learned patterns of recognition.
Now that you have read Simon, Arrow, and Sen, you are on your way to being able to name and discuss the contribution of five institutional economists who won the Nobel Prize.
Review Questions:
2. Implications for methodology? Talk is cheap, or is it? (Answer)
3. Micro-economic theory is ambitious and institutional theory is no less so. Can you explain: Flood insurance purchase, growth in women's entry to the labor force, crime rates, economic growth in U.S., Japan, Germany and LDC's, size distribution of firms, voting behavior, sticky prices in recessions? Does your explanation affect your policy suggestions?
4. Can you relate Hodgson to the former reading in Samuels?
8: INCOMPATIBLE USE AND EXCLUSION COST
From Period 2 and C&C, we have a start on a general paradigm (SSP) for relating property rights structure to performance and some ideas on human behavior from the last three periods. Now, we must get into the nitty-gritty of classifying sources of human interdependence in a way that when alternative rules are applied, we can begin to predict the directional performance (or ala Williamson, given the situation, predict what institutions will exist). The material is relatively abstract. Try to keep in mind examples from your experience that fit into these boxes of incompatible goods, exclusion cost, and etc.
A. C&C. What type of rights control human interdependence arising from incompatible uses (IUG)? Little space has been given to IUG interdependence not because it is unimportant, but because the impact of factor ownership on performance is relatively straightforward. The tougher question is how conflicts over factor ownership can be worked out peacefully (note I did not say efficiently). A contemporary case of IUG land conflict can be seen in Nigeria. A big time issue of IUG is control of Russian oil.
We are currently witness to one of the grandest experiments in history regarding the distribution of incompatible use goods as the former communist countries and many countries in Africa distribute state assets. Did they to go to the highest bidder (those who already own many assets), the workers in the factory, or to every citizen? We will consider this more in Period 25 on market institutions.
How do these differ from those rights controlling interdependence arising from high exclusion cost (HEC)? If you would like another and longer description of the different sources of interdependence, see Schmid's previous book Property, Power and Public Choice, Chs. 3-7.
1.Make a list of high exclusion cost goods. How do the rules for their provision affect who gets what? Are all of them provided by government? How do alternative rules affect the welfare of the gambling or unwitting free rider and the unwilling rider? Note: "Free rider" and "unwilling rider" are technical terms applying only to HEC goods, i.e., an IUG loser is not an unwilling rider. (For a taxonomy of the parties involved in HEC goods see, Journal File.) What kind of good is knowledge and information? What will a public research firm produce vs. a private firm? We will look at this again in Period 21 on technology.
2. Common property is a rule structure which prohibits exclusion in some dimensions as a matter of policy rather than high exclusion cost being inherent in the good. What are the consequences?
3. Status-grant is the only structure for HEC goods that avoids both free and unwillling riders.
B. Some key concepts from Olson: inclusive, exclusive, privileged and latent groups. What are the advantages of small groups? Focus on the substantive consequences for group formation. Olson uses the term "collective goods" but it is clear he is speaking of high exclusion cost goods (pp. 28 & 35). Does it make any difference what term we use?
1. Which is more free and democratic -- labor unions maintained by closed shop rule or the Farm Bureau lobbying effort maintained by profit on services where exclusion is cheap (e.g., feed and insurance)? (Such a question is a variety of welfare economics.) Students of agriculture may wish to read Olson's discussion of the Farm Bureau, pp. 148-159. What is the parallel in environmental groups?
2. James Buchanan argues that in large groups there is no strategic bargaining to attempt to be a free rider but merely each person can't see that his contribution will make a difference. Can any society afford to fail to acculturate (socialize/reinforce) its members so that participation in some group activities is not calculated but simply a matter of habit. (Recall Hodgson's definition of an institution as a durable and routinized pattern of behavior.) Can a habit be a property right? A sense of community and benevolence is critical. A. Etzioni's The Moral Dimension (1988) and the works of K. Boulding and J. Taylor (noted in PPPC, ch. 2) are relevant here. Large group preferences are costly to express (at the extreme, impossible) without benevolence or at least some learned non-calculation of advantage.
3. Have you ever heard someone argue against government regulation or provision of a good by saying that if people wanted it they would have bought it in the market? What can be said about this claim? (Welfare Econ. Theory)
C. Hirschman (optional) is more optimistic than Olson about the provision of HEC goods, but, note the size of groups he describes.
I want to impress on you the importance of observation and experimental economics (more in Period 22). We need not begin our analysis with assumptions on human behavior as does Williamson or Olson. People are sometimes opportunistic and sometimes not. How do institutions affect which behavior occurs? Dawes demonstrates that just a few minutes of conversation affects opportunistic behavior. Other designed institutions can be expected to have great impact. Recall Sen's distinction between sympathy and commitment. Recall Elster and the role of emotion. People get mad at non-cooperators.
Review Questions:
1. What is the difference between the so-called externality of smoke from steel production causing cancer and the interdependence caused by ordinary incompatible use such as when Alpha consumes food, Beta goes hungry? Did your last meal create an externality? Could the effects have been compensated for? Compare your answers to Journal File.
9. BEHAVIOR THAT DEPENDS ON BEHAVIOR OF OTHERS
In designing this course, I have tried to not only introduce you to basic concepts but also to sample from the work of the leading scholars in institutional and behavioral economics. Tom Schelling certainly deserves to be on that list. He was Prof. of Economics and long time on the faculty of the Kennedy School of Government at Harvard. He is now semi-retired and teaching at the University of Maryland. He was president of the American Economic Assoc. and its annual proceedings appearing in the AER, May, 1991, reflect something of his agenda. Institutional economists tend to be highly individualistic with somewhat unique agendas and language, so it is hard to summarize his work, though putting it in SSP terms helps. Therefore I have selected several of his articles reprinted in Micromotives and Macrobehavior. This book is available in paperback published by Norton and you might like to have it for your library.
A. Schelling "Explores the relation between the behavior characteristics of the individuals who comprise some social aggregate, and the characteristics of the aggregate (13)." "People are responding to an environment that consists of other people responding to their environment, which consists of people responding to an environment of people's responses (14)." This echoes Arrow that rationality is not the property of the individual alone.
Note his behavioral observations: "we can get carried away with our image of goal seeking and problem solving. We can forget that people pursue misguided goals or don't know their goals, and that they enjoy or suffer subconscious processes...(19)"
"There is no presumption that self-serving behavior of individuals should usually lead to collectively satisfactory results. Economics covers a special case....(25)" Finding an equilibria is not to find something that everybody likes, only that nobody alone can do better by changing anything. Collective action is the only way for an individual to get what she wants. (Contrast this to the conception of the individual vs. the collectivity.)
Ch. 2 analyzes a class of "patterns that have the characteristic of tending to be realized in the aggregate no matter how the individuals behave who comprise the aggregates." I can't do any better in introducing the chapter than Schelling's own study guide from his Harvard course--"This chapter is self-explanatory. Starting on p. 56, I wish you would try in each section to think of an example of your own. I might ask you for examples on an examination, and you couldn't provide them unless you'd been warned in advance." Are these subtle IUG interdepencies?
Again from his guide, Ch. 7 "is the only hard chapter in the book. It takes a good deal of care and thought to understand the diagrams: it then takes a lot of practice to be able to read them and work with them, more practice than you will probably get. Don't be frustrated if you continually have trouble keeping in mind how to read the diagram. You are not losing your mind: it takes a while to become fluent. And once you've got it, it's an extremely useful tool." We will also spend next period on prisoner's dilemma problems. What has all this to do with exclusion cost, if anything?
Schelling is not about how we affect each other's preferences, but rather each other's environment.
Note: The "L" function in Figure 14, p. 220, is the value to a person of choosing the preferred option as a function of the number of others choosing the unpreferred option. The "R" function is the value to a person of choosing the unpreferred option as a function of the number of others also choosing the unpreferred. How do these figures differ from Olson's, p. 32?
One hallmark of institutional economics is the transaction as the unit of analysis (first paragraph p. 76). His figures of the value to a person as a function of others choosing the unpreferred options p. 220 imply an interdependent transaction (not necessarily an exchange). He says p. 219 that "Matching the pictures in Figure 14 with actual situations is good exercise but I leave it to you." I follow the master's example, you may wish to do the same.
Review Questions:
1. What does Schelling's analysis suggest about impact of alternative institutions? Could he use some help from Dawes and Hirschman?
2. For your journal file it might be helpful to assemble some of the situational (model or patterns) cases Schelling describes and then for each try two or more alternative institutional structures and hypothesize the associated performances. His list of situations (he calls them "structures"--confusing isn't it?) includes: PD, MPD, interactive (adaptive) behavior (is this the same as Olson's large group case or the situation Dawes created in his lab?), "propositions that are true in the aggregate, but not in detail, and true independently of how people behave," quantities that are the growth rates of other quantities, etc. He lists some SSP categories including HEC pp. 29-30. See his taxonomic list p. 73, the numbered paragraphs pp. 76-79. These "patterns" are all sources of interdependence in the language of SSP. He lists some alternative institutional structures, middle of p. 224. After you have tried modeling some of Schelling's situations, have a look at my Journal File.
3. Dolphin loving U.S. conflicts with hungry Mexico. U.S. culture shaped by the TV show "Flipper" makes eating dolphin taboo. Mexico allows netting of tuna in its waters to supply international markets. But tuna nets also catch dolphins and some die before they can be released. Can you model this conflict and use SSP to hypothesize the performance of alternative institutions? Journal File.(For another application to housing conflicts in East Lansing, see Journal File.)
10: PRISONER'S DILEMMA (PD) and Other Games
You can experiment with Prisoner's Dilemma games on the web. A simple one is http://www.princeton.edu/~mdaniels/PD/PD.html
A more complicaed one is http://www.xs4all.nl/~helfrich/prisoner/
I was impressed when I read that there is more literature on Prisoner's Dilemma (PD) than any other topic in the social sciences. So I guess it deserves at least one period of its own in a course on public choice. Some refer to PD as a social trap. It has the characteristic of a dominant solution for the maximizing individual. Note that the key characteristic is not myopia or lack of information. In what ways are PD and HEC similar? (Both have a dominant choice.)
B: Bowles, "Social Interactions and Institutional Design." "My main objective in this chapter is both to introduce some basic ideas of game theory and to use these ideas to provide a taxonomy of social interactions and their outcomes." 27 He distinguishes cooperative vs. non-cooperative games and common interest vs. conflict games. How does his taxonomy differ from that of C&C? How does Bowles use of the term "structure" differ from that of C&C? To solve coordination problems he suggests changing the game structure (44). What if the structure is inherent? Can everything be represented in a payoff matrix? Are the rules different from the payoff matrix? If Pareto efficiency "does not provide much guidance in making policy choices" why does he "make extensive use of the notion of Pareto efficiency." 24-5 What does it mean to take account of the effects of one's actions on the well-being of others? Cf. C&C 72-3. I thought the advantage of having a property right is that you do not have to take account of what others might like that disadvantages you. Note Bowles definition of institutions, p. 47 bottom. Note the word structure. Cf. C&C p.6. Can all institutions be represented as a game? C&C speaks of the transaction as the unit of observation. Is this different from the game as the unit? Coordination is the given objective for Bowles. Alternative institutions are to be tested by their ability to "avert a particular coordination failure (54)." Coordination failures are inefficient. How is this different from C&C? Recall the distinctions among economizing, power, and knowledge, C&C 26.
Can you distinguish various games: PD, assurance, invisable hand, division, and stag hunt.
Review Exercise:
If you are looking for a contemporary PD problem to practice on, take a look at "Will Proctor's Gamble Work?" Progressive Grocer, July, 1992, which describes how food retailers are trying to get out of the trap of offering forward buying volume discounts which cause retailers to buy and store and waste resources. Try to use the behavioral findings of Hirschman, Dawes, Frank and Axelrod if you were a consultant to Proctor and Gamble. P & G hope they are large enough (iron fist) or persuasive enough that all will follow them. But, if the situation is MPD, there is a dominant choice for others regardless of what P & G does, i.e. defect and buyers will flock to the defectors even though the buyer might prefer an industry w/o volume discounts.
Notes and observations:
1. What is researchable about PD and CG situations? From the last several periods you should have assembled a journal file listing alterative structures (institutions) that may unhorse the free rider and achieve cooperation (performance). These include institutions that vary the number of players, number of rounds, communication among the players, arouse a sense of group identity (Dawes), trigger our emotions (Frank), learn tit for tat (Axelrod) learn trust (Hirschman), Leviathan (Olson), invokes the sacred (Harris), and rearrange current reinforcers (Platt). Reflect on your experience to find examples where variation in these structures seem to affect performance. Can you think of opportunities where we might gather more data on the SSP connections?
2. Hirschman (in Period 8) observed that experience with collective action builds a base of trust which allows groups to succeed and avoid the paralysis of opportunism. Philip Favero in his 1977 MSU Ag. Econ. thesis, The Process of Collective Action: Small Electric Companies in Michigan, found that small electric companies could take advantage of economies of scale in joint generation plants only with a previous experience of trust building in smaller collective efforts.
I have been curious about why certain communities are able to sustain collective ventures such as volunteer fire and ambulance service, blood drives, soil conservation districts, or contributions to public TV. But perhaps equally important, is the presence of one non-opportunistic behavior associated with others? For example, is a community with a volunteer fire department also more likely to be free of litter and graffiti?
3. The opposite of a social trap (PD) is where the individual who initiates a new action does make a difference and forces other to follow. This is the "iron fist" (or invisible hand) of competition that can be used for good or evil depending on your interests. An example is Cochrane's agricultural treadmill--a farmer must adopt a new technology even when she can see that in the long run all benefits will accrue to consumers and overproduction may result. Consider the current prospect of the adoption of bovine growth hormones. Usually if a few adopt it, others are forced to follow. You are a sucker if you don't. But, this one may be different. Most of the milk is sold to cooperatives. What if regional co-ops decide that they won't buy bST milk? The abstainer doesn't have to worry about being alone. Either all refrain or all adopt. All majority rule financing of public investments is of this type. The institution avoids the consequences of lack of assurance. It is a way of contracting to act together rather than sticking your individual neck out. (But, then so are cartels.)
4. "Neural Basis of Altruistic Behavior, Science," 27 August 2004. Abstract: Many people voluntarily incur costs to punish violations of social norms. Evolutionary models and empirical evidence indicate that such altruistic punishment has been a decisive force in the evolution of human cooperation. We used H2 15O positron emission tomography to examine the neural basis for altruistic punishment of defectors in an economic exchange. Subjects could punish defection either symbolically or effectively. Symbolic punishment did not reduce the defector's economic payoff, whereas effective punishment did reduce the payoff. We scanned the subjects' brains while they learned about the defector's abuse of trust and determined the punishment. Effective punishment, as compared with symbolic punishment, activated the dorsal striatum, which has been implicated in the processing of rewards that accrue as a result of goal-directed actions. Moreover, subjects with stronger activations in the dorsal striatum were willing to incur greater costs in order to punish. Our findings support the hypothesis that people derive satisfaction from punishing norm violations and that the activation in the dorsal striatum reflects the anticipated satisfaction from punishing defectors.
Web sites where you can play at PD: http://netrunners.mur.csu.edu.au/~osprey/prisoner.html
more on interactive PD http://plato.stanford.edu/entries/prisoner-dilemma/
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11. INCREASING RETURNS
A. C&C,. Increasing returns (economies of scale) are the source of major interdependencies and disequilibrium.
1. Are there any natural resource products that fit the case of decreasing costs to scale? Are they now governmental or privately produced? If private, are they regulated? Do some eventually reach a scale where marginal costs rise, e.g., congestion? Think of cases of ec. of scale creating a tradeoff between cost per unit and variety. An agricultural example is the tradeoff between monoculture and bio-diversity. Europe has more varieties of apples, potatoes, and cheese than the U.S. Are costs thereby higher?
Economies of scale require raising of capital from many otherwise unrelated investors. The limited liability corporation helps. This is a major problem in some poor countries where trust beyond the family is not customary. Relate to DeSoto and the role of contract rights in developing countries (Period 25).
2. Am I more (or less) coerced by higher prices for decreasing cost products I like caused by others reducing their demand, or by special transportation fares which I can't qualify for, or by firms practicing price discrimination, or price and quality regulations of cable TV or electricity?
3. If you have the time, you might look at Williamson's treatment of industries with extraordinary economies of scale in his big book, The Economic Institutions of Capitalism, section 2.1, pp. 330-1 where he explores franchise bidding as an institutions and sets aside the marginal cost pricing issue. Contrast to C&C that argues that the sharing of fixed cost is the major interdependence caused by economies of scale. C&C critiques the presumed acceptance of the marginal cost pricing rule of welfare economics because it begs the question fixed cost sharing. The organizer of the franchise bidding will have to specify (give rights) the initial hook up charge relative to continuing monthly charges as well as worrying about whether the total revenue equals total cost. Williamson hints at the problem in footnote 8, p. 335. Williamson's agenda is to find the efficient institutions, and when he finds situations where one institutional alternatives economizes in one direction but not another (feasibility vs. execution costs) while another institution just reverses the positives and negatives, he leaves the field and just says that there is no strong case for either. Since he is not interested in questions of power, the differences in income distribution are not highlighted for choice. If consumers care about sharing of the non-variable costs, there is no way to achieve a given sharing without government writing it into the franchise contract and bearing the execution costs.
4. Econ. of scale means that there is no unique industry equilibrium and therefore the institutions which shape which path is chosen become critical. PPPC describes interdependent paths of consumer preferences (product brand market shares) and costs per unit. The same points apply to choice of technologies and the geography of firm location (see Storper and Walker, The Capitalist Imperative: Territory, Technology, and Industrial Growth, 1989.) Also recall Arrow's discussion of evolving equilibria. Gunnar Myrdal referred to this phenomenon as "cummulative causation."
Equilibrium economics (Newtonian physics) assumes that allocation is preordained by patterns of resources, preferences and the production function. But, evolutionary econ (nonlinear physics) observes mutual reinforcing elements in which random history can start us down a path whence we become locked-in as a series of efficient choices may produce a regretted outcome, again raising the question of possible collective action so that individuals can get what they want. This theory is especially relevant today as we debate industrial policy and competition with other countries. Increasing returns is central to the arguments for protection of infant industries in developing countries.
5. C&C, section 6.6 "Circular and Cumulative Causation," is a way to think about the path dependency associated with economies of scale as products compete with each other. But, economies of scale is not the only process with feedback, reinforcers, and amplifiers as noted by Arthur and Skott below.
B. Brian Arthur speaks of "sources" of self-reinforcing mechanisms in language reminiscent of sources of interdependence. To the situation of large set-up or fixed costs he adds "learning effects (which act to improve products or lower their cost as their prevalence increases; coordination effects (which confer advantages to 'going along' with other economic agents taking similar action); and adaptive expectations (where increased prevalence on the market enhances beliefs of further prevalence)." Note the useful addition of cognitive processes here. Arthur gives a number of examples involving technology standards such as Betamax vs VHS video cassette formats and which railroad gauge to use. A current example is the competitive advantage enjoyed by Microsoft (see, John Cassidy, "The Force of an Idea," The New Yorker, Jan. 12, 1998.) Even if its operating system were not better than any other it has the path advantage of having more software written for it and its on-line communications service may have an advantage because of ease of use once Windows is is place. (See my Journal Note on the path dependence in computers, "Revenge of the Nerds" in Period 27 on technology and other clippings on course web page.) Explicit collective action is required if we want to get off a path domnated by a particular economies of scale good.
This literature is expressed in many different ways. I just now understand the connection to Schelling who speaks of the problem of "mixing and sorting" and applies it to evolving racial segregation in housing. Both involve non-linear emergent processes that can be set in motion by small random changes.
---Arthur's involvement in the Microsoft anti-trust case http://www.pretext.com/may98/columns/intview.htm
C. Skott. Nobel prize winner Gunnar Myrdal developed the concept of "cumulative causation." The interdependence arises from interaction of cognition, expectations, and the effects of inequalities. Cumulative causation is an essential tool for institutional change analysis. Periods 8-13 focus on impact analysis, but increasing returns and other sources of feedbacks, reinforcers and amplifiers also point to change analysis of Periods 16-17.
12: NON-RIVAL GOODS (Marginal Cost of another user equals zero)
1. It might appear that a good which can be utilized by one person and not be consumed and therefore available to still another user would be the best of all possible worlds. But, alas it is just one more situation of human interdependence where collective choice determines whose preferences count. Try to understand the character of this interdependence and how alternative rights interact with it to influence who gets what.
2. There is a lot of confusing language about MC=0 goods. What would you call it?
3. Test your ability to categorize goods by finding additional examples to put in the boxes of C&C Table 6.4. Then practice applying a particular rule (e.g. regulation, market, or government enterprise) to each box to see how the character of the interdependence affects the performance that might be expected with the rule. (Are you clear on why there are no low exclusion cost goods where avoidance is non-optional?) Do not confuse goods and rules (rights).
4. Be sure to understand the key proposition that states -- with joint-impact goods whose use is optional (low avoidance cost), the issue is who pays how much. If it is provided by government the question of tax incidence is critical. Whether publicly or privately provided, the argument over cost sharing may prevent production of the goods. But, with non-optional goods, the issue can also be who gets to choose the good. Government regulation of private consumption may be necessary to make effective the preferences of others negatively affected.
5. Some literature speaks of "public goods" and fails to distinguish between high exclusion cost and joint-impact characteristics. Be sure you understand the different implications of each alone and in combination. Can you think of any good use for the imprecise and loaded term "public goods?"
6. Note that MC = 0 over some range. There is frequently some threshold where congestion sets in. When the quality of the good changes we can not speak of MC = 0. Consider Breton's definition of a "non-private good," PPPC, p.77. Maybe we have MC = 0 up to some point, then a range where congestion is felt but another user does not reduce that available to another previous user by an equal amount.
7. The provision of MC=0 goods involves sharing the fixed cost. There are some parallels here with the ultimatum or chicken game. Learned notions of fairness seem relevant here. See Frank, Passions Within Reason and the study notes for period 10.
Review Questions:
1. Make a list of MC = 0 goods. Is knowledge and information on it?
MC=0 is the stuff of private fortunes. Can you think of examples?
For an elementary discussion of marginal cost equal zero concepts see, Francis Bator, The Question of Government Spending, Chs. 6 & 7.
For more see, PPPC, Ch. 5.
(This begins a series of three periods on different aspects of transaction costs. For a raodmap to future periods from a trnasaction cost perspective, see concept map)
In the model of pure competition, information is assumed perfect and transaction costs zero. Within the neo-classical framework we ask whether reality is close enough to these assumptions for the efficiency conclusions of the theory to hold and the institutional design task becomes how to reduce transaction costs. This does not call our attention to those rights which affect who bears the consequences of these costs--a power question.
Ronald Coase won the Nobel Prize in 1991 and popularized the concept of transaction cost. He used the concept to explain the existence of the firm (form of business organization) and the effect of IUG ownership (liability) on resource use. The concept has even more uses. Is it useful to divide transaction costs into contractual and information costs? For the essence of Coase, see Eggertsson, pp. 19-20 assigned in Period 2.
A. C&C suggests four subcategories of transaction costs: information (on quality), contractual, asset specificity exposure because of the opportunism of trading partners, and fundamental uncertainty..
Contractual Cost:
1. C&C explores the substantive consequences of contractual costs interacting with alternative structures such as reasonable use, injunctions, covenants and class actions for consumers, business and voters. Contrast to the agenda suggested by the Coase Theorem as described by Eggertsson (assigned in Perioed 2). We will come back to the efficiency question in Period 20. As you read the assigned material, you will note the difference between the agendas of positive analysis (who gets what under alternative rules) and efficiency (does the resource go to the right use given some rules).
2. How does the availability of injunctive vs. damage relief affect the interests of factor owners? Does knowledge of factor ownership give the whole picture of eventual wealth distribution?
3. Ownership of an opportunity is only as real as the cost of pursuing redress when it is stolen. How does the additional right of class action affect the value of factor ownership or other rights? Is the transaction cost of seeking court protection just a variety of our earlier category of exclusion cost? Can you use contract cost concepts to understand the issues and consequences of the Kinko Copy royalty suit and why our course pack is reproduced at Budget Printing?
Information Cost:
4. Develop a list of product and other situational characteristics that determine information cost. Included are technical complexity, frequency of purchase, and implicitly, product homogeneity. How do these create opportunities for one person to affect another? Is it controlled by degree of competition? How does the rule of merchantability, futures markets, selling livestock live or by dressed carcass, prohibition of sealed bids and cost-plus contracts affect income distribution? Where quality is hard to determine, firms spend much on product differentiation--is this a transaction cost?
5. Information is treated somewhat differently by students of comparative systems. They speak of the content of information received by the enterprise (prices or performance requirements); degree of centralization of information (does sender alter information according to who receiver is?--see Pryor, p. 342); information channels (p. 266) at the enterprise level are distinguished (vertical, horizontal or oblique); with respect to communication between the center and the enterprise (organized on the basis of similar products, functions, or territorial), (degree of duplication of parallel lines of information), and (number of iteration allowed, i.e., plans and counterplans). How do these fit into the text concepts? While Pryor distinguishes between information and control concentration, most empirical tests of impact are at the country level which necessarily combines their effect.
6. Distinguish the cost of producing information arising from the physical production function from information/transaction cost arising from the interaction of buyer and seller.
Bonus: The cost of determining product quality is at the heart of many problems in developing countries. For example, it is difficult to reward producers of arabica coffee for careful production since it is difficult to look at the beans and tell if they were handled correctly. These problems are discussed in depth in Robert Klitgaard, Adjusting to Reality: Beyond State vs Market in Economic Development, 1991, Ch.3 "Information and Market Institutions." The one page table from this work in your course pack is suggestive.
B. Williamson
Asset Specificity:
1. Williamson makes asset specificity the center of his universe. Here he refers vaguely to "contractual hazards." HIC could be one of them, but he mostly refers to specific asset prblems under uncertainty. Williamson notes a "fundamental transformation" where a buyer has a choice from many competing firms initially, but faces a monopoly later becaue of immobile assets. Choice of market or integrated firm depends on the net effect of high powered (profit) incentives and sequential adjustments to disturbances (changes in demand and technology).
2. Consider the role of hostages in making credible commitments. Are these devices great for everyone (no power issue)?
3. Note the similarities and differences between Williamson and C&C. He notes three situational variables of uncertainty, frequency of transactions and asset specificity (immobile assets). His structural variables are types of "governance". What are his performance categories? C&C seems to regard immobile (specific) assets as just one of many consequences of imperfect information
Contrast Arthur and Williamson. Both identify a kind of "fundamental transformation" from competition to oligopoly-monopoly, but the source of interdependence creating change is different.
Practice applying Williamson's theory to some recent mergers such as are occuring in the communications industry.
4. Williamson distinguishes governance costs from measurement. This parallels C&C's distinction between contractual and information costs. Williamson focuses on governance-contractual costs and does not elaborate the problem of information disparity and then says little about consumer information rights. But not all contractual cost derives from opportunism in the context of asset specificity.
5. Where do you think the greatest losses have (will) occur -- in unused immobile capital or irreversible commitments of natural resources?
6. Distinguish the interdependencies created by uncertainty in:
taking into account the degree of irreversibility in the use of immobile assets and resources which, if once committed to a line of production, can not be committed to another. Keep clear on whether the interdependencies are among producers or consumers or both.
7. Williamson in his big book, The Economic Institutions of Capitalism, p. 176 argues that price reductions from using efficient, but specific technology are not awarded gratuitously. Agriculture seems to be an exception. Why? Williamson is concerned with assets that are specific to a transaction, not to a whole industry. He says that the principal assets used in farming--land, machines, and growing crops are highly redeployable and this makes it easy for farmers to finance their operations with debt. So family farms survive as they do in large part because farming involves very low levels of asset specificity. Do you agree?
Review Questions:
1. Develop an SSP Chart for Williamson. Journal File.
2. Develop an SSP Chart contrasting the structures that are relevant for information cost, contractual cost, and costs arising from asset specificity. Journal File.
For another version of this material, see PPPC, Ch. 5..
14. UNCERTAINTY AND INFORMATION PROCESSING COSTS
If you write a paper today, consider taking some non-routine business or government decision and construct a scenario of how you (or an actual manager) would (did) make the decision, e.g. the Michigan governor pushing through an increase in the cigarette tax to meet a projected budget shortfall or Monsanto's decision to develop genetically modified organisms.
A. C&C
1. Economic decisions are made under conditions of uncertainty and bounded rationality. Because of the C-D gap, Heiner argues that it is essential to simplify behavior to deal with uncertain situations and that this is done by developing what may usefully be considered behavioral rules. And that uncertainty generates rules which are adapted only to likely or recurrent situations, that selection processes do not simulate optimizing behavior, and that weak selection processes (no immediate reinforcement) may allow dysfunctional behavior to persist. If he is correct, what implications does that have for economic theory, analysis, and your own paradigm. Journal File.
2. We deal with uncertainty by developing behavioral rules (heuristics and SOP's) and by attempting to control the environment to reduce the uncertainty. It is one thing to buy insurance to reduce risk and quite another to control the source of the uncertainty. Much of the organization and behavior of firms is influenced by the effort to reduce uncertainty. A service is produced by employees rather than by counting on the market etc. Similarly we develop institutions or generally accepted ways of relating to each other to reduce the uncertainty of each others behavior.
3. How do your respond to Heiner's conclusions, particularly, "the factors that standard theory places in the error term are in fact what is producing behavioral regularities, while optimizing will tend to produce sophisticated deviations from these patterns"?
4. On institutional change/evolution, relate Heiner to Williamson and North. North wants to remove frictions, but Heiner observes that people erect barriers to some options so that they can better predict their environment that is made up of other peoples' choices, also Schelling. Friction removal assumes that everyone knows what gains from trade exist, but Littlechild says that the problem is not discovery of the future, but its creation.
5. Can analysts do better at predicting behavior by eliciting SOP's than by making the calculations that an unreal rationalist might make? If we use expected value we would predict purchase of flood insurance. In fact people seem to use a SOP of ignoring most low probability disastrous events, except when framed with dread, etc.
6. Where is conflict and power in Heiner? Heiner speaks of evolving SOP's and Leibenstein of "effort conventions." Leibensten, however, says slack may be productive if it reduces internal conflicts and creates loyalty.
7. What are the implications for developing countries? If their entrepreneurs don't have the right SOP's, where do they come from?
8. What SOP's do consumers invent for the C-D Gap? Recall earlier discussion of lexicographic choice (Earl). Recall concept of "pattern recognition" (Margolis) and the difference between "seeing that" (Lincoln picture) and "reasoning why." Heiner derives the "Law of Demand" w/o the usual calculation from indifference curves (see his article, pp. 579-80 and footnote 46).
B. Potts -- things I have underlined and ruminated on:
1. "Agents use internal models to process environmental signals into expectations."
2. "Preferences are themselves expectations." Recall C&C section 3.3.5, predicting plesure-pain .
3. "Attitudes, belilefs, hypotheses and conjectures...are products of local, discrete interactions." 162
4. What do you think of the standard approach of attaching probability weights to a known list of possible futures? c.f. Potts, 167.
5. Can the future be made comprensible if observation and stability fail? 171 Are many decisions unique, irreversible and of crucial importance? How does Potts get from here to a conclusion that "agents standardize their behavior in terms of rules (172)." Plans, expertise and expectations are outcomes of learning SOP's and mental models formed in transactions with others (connections). Again, Potts is very abstract. Can you thinks of real cases?
C. One of our interests is in identifying different paradigms or ways of looking at economic analysis, especially in respect to different concepts of economic behavior of decision making. Littlechild (optional) in this brief article looks at three approaches to understanding market processes. His emphasis is on perception and behavioral assumptions or perspectives (Situation) associated with different schools of thought. If we believe that our theories should explain the observable world in the domain of the theory and we observe decisions made entirely under conditions of uncertainty, which of the three sets of assumptions (observations) is likely to be most useful in a paradigm for economic policy analysis? What are your arguments with the author's conclusions?
1. What alternative institutions have been developed in different countries to imagine and "create" the future ala Littlechild? Contrast industrial organization in the U.S. with Japanese Keiretsu and Germany's reliance on banks to provide coordination.
2. One of the points of SSP is that you can't predict the impact of alternative institutions unless you know how the character of goods and minds affect human interdependence. Different sources of interdependence cause a given rights structure to perform differently. So would you expect a given right to have a different effect if the interdependence is coming from measurement problems (cost of understanding the quality of a good), variation in weather, opportunism of trading partners made possible by changes in demand and technology (Williamson), or radical undertainty where the range of values and even the set of products in unknowable (you may not even know who your trading partners or competitors will be)? Can you put these various varities of transaction cost in SSP outline form? Journal File.
Review Exercise:
1. Develop an SSP chart for both Heiner and Littlechild. Journal File.
15. INSTITUTIONS AND ORGANIZATIONS
Organizations: "Groups of individuals bound by some common purpose to achieve objectives." "Organizations provide a structure to human interaction." "The focus on organizations (and their entrepreneurs) is primarily on their role as agents of institutional change." (North) Organizations include political bodies, firms, unions, cooperatives, churches, universities. Here we see networks of relationships both hierarchical and overlapping--independent and dependent variables. Organizations have structural opportunities shaped by higher level institutions and in turn, groups of individuals act to change these institutions partly as a function of the choice of organizational structure.
A. C&C. Organizations are the norm, and markets the exception.
B. Simon has written extensively on organizational behavior; note the references to his own work. Here he argues that economies in modern industrial societies are better called organizational economies than market economies. He outlines a theory of organization and then continues arguing that the theory calls for reexamining some of the classical questions of political economy. Most of us believe we know what a firm is and the distinction between coordination within and between firms across markets, as Williamson discusses in his transactions economics, is clear cut. But Simon wants us to rethink the paradigm. So what?
Simon (like North) observes loyalty even where opportunism is possible. He says not to take people's utility function as a given. Ditto for transaction cost saving ability of hierarchy. Note problem in the weight of the evidence. Williamson says he can predict market or hierarchy while Simon says it is fragile.
The situational variables in Simon are monitoring and information costs. This creates a problem to achieve obedience to command (measurement problem) w/o losing the benefit of delegation and specialization. His structural variables are authority embedded in necessarily incomplete contracts, reward, and identification/loyalty.
C. Hodgson. Coase and Williamson explain firms as an economical way of coordinating known pieces of the production function. But Hodgson (and Nelson & Winter) see the firm as a way of generating knowledge to create new possible production functions in the face of fundamental uncertainty (situation). It is not possible to speak of maximization when the materials are unknown. "The basic behavioral premise is that a firm at any time operates largely according to a set of decision rules that link a domain of environmental stimuli to a range of responses on the part of firms." N&W, 891. Hodgson is vague on structural details, can you elaborate?
Too much is made of creating incentives for agents to avoid opportunism and shirking. The bigger probelm is competing visions of possible futures to be created.
Review Questions:
1. What can be understood with the "competence theory of the firm" (the network's ability to make connections) compared to the Coase-Williamson version (firms as locus of contract and economizing of transaction costs)? Coase assumes objectives are known and the only problem is gettting thre--economize transaction costs.
Develop an SSP chart for Simon's organizations and markets. What sources of interdependence is he emphasizing (especially note pp. 32 & 34)? Journal File.
16. INSTITUTIONAL CHANGE (1) Overview
If you write a paper today, you might take a specific historical change in a significant institution of interest to you and make a start on explaining it using ideas from the readings such as functional, power, learning and isomorphic theories. Do these processes cover the possiblities? A fascinating case to work with is the evolution of women's suffrage in the US. A Ken Burns documentary entitled "Not For Ourselves Alone" is available on reserve in the Media Library, 4th floor west, Main Library. If you do this one, your paper may be 3 pages. For a video preview, see http://www.pbs.org/stantonanthony/
A. C&C. . Evolution involves processes that increase variety, some selection that reduces variety, and reinforce persistance. It is necessary to understand the process of human cognition which frames (interprets) experience into categories with actions attached. Can we use the situational characteristics used in impact theory to understand change in institutions? The political rules for making rules are critical for changes in formal institutions. But what is strategic for change in informal institutions?
Keep in mind Period 11 and the concept of increasing returns. Equilibrium economics (Newtonian physics) assumes that allocation is preordained by patterns of resources, preferences, and the production function. But, evolutionary econ (nonlinear physics, complexity and emergence) observes mutual reinforcing elements in which random history can start us down a path whence we become locked-in as a series of efficient choices may produce a regretted outcome, again raising the question of possible collective action so that individuals can get what they want. This theory is especially relevant today as we debate industrial policy and competition with the Japanese with their networks of industrial conglomerates and government. Increasing returns is central to the arguments for protection of infant industries in developing countries.
B. Optional: Castells-- This is the best thing I have read on social movements and informal institutional change. Castells' theme is essentially the role of emotion in the search for identity to create an informal process that avoids the free rider problem of HEC. If you are curious about Islamic and Christian fundamemntalism today, you won't be able to put this down.
I wish we had time for Potts, Chs. 3 & 4. For some highlights see my Journal file, "Systems Theory and Complexity."
A. North, 1993 Nobel Laureate, is an economic historian who, in trying to explain the economic world he observes, has come to an analytical framework which emphasizes institutions and transactions costs. Our previous periods have been impact analysis. North combines impact analysis with change analysis. Impact question: How do institutions differ between rich and poor countries, i.e. what is the impact of institutions on development? Change question: Why institutions change or persist over time? e.g. why was a balanced budget an obsession of many in the U.S. and then dropped off the agenda?
North's basic question is how do you explain the great differences in economic performance across space and time. North's model case compares England and Spain. This is surely a very important question. A USDA report addressed the question of the explanation of the differences in total agricultural productivity among 26 countries. It used six independent variables (research stock/number of farms, GDP of transportation and communications industries/total land area, arable land at end of decade/arable land at beginning of decade, value of net exports of agricultural inputs/aggregate input index, and number of agricultural college graduates/10,000 farmworkers) none of which directly represented significant institutional or transactions costs differences. The regression R square was .94. Is this evidence that North is dealing in speculation without real evidence to support his case? (Frisvold and Lomax, Differences in Agricultural Research and Productivity Among 26 Countries, Agricultural Economic Report Number 644 ERS USDA 1991.) Or, do institutions explain the variables in the above equation? Institutions are not factors of production (C&C, p. 70).
1. What are the central propositions in North's analysis? Can you write out the basic theory in several pages of your JF? Note his distinction between organizations and institutions. (Organization of organizations was the topic of period 14.) Key case to illustrate his theory is the comparison of England and Spain, pp. 113-16 and 138-39.) See Journal File for putting this case into SSP terms.
2. This is a very broad brush analysis. What are the most important ideas useful in thinking about your area of policy analysis? What ideas are most useful to you in developing a meta framework for approaching policy analysis?
3. North frequently refers to efficient institutions. What does this mean? How important is the concept to North's story? How would you improve his analysis with a clearer concept of performance? Understanding what North means by an efficient institution is critical to understanding his story (p.8). How distinguish production and redistributive activity?
4. How do you react to these statements from the book?
a. "....the inability of societies to develop effective, low-cost enforcement of contracts is the most important source of both historical stagnation and contemporary underdevelopment in the Third World. p. 54. Samuel Bowles and Avner Greif would agree.
"Institutions affect the performance of the economy by their effect on the costs of exchange." p.5 Does it make any difference who has what to exchange? Recall Period 2, item 2 in these study notes.
The major role of institutions in a society is to reduce uncertainty. p.6
b. His model of institutional change is summarized p. 86. The agent of change is the individual entrepreneur responding to incentives embodied in the institutional framework. The sources of change are changing relative prices or preferences. (Does price contain enough information?) Is institutional change simply economizing or the result of changes in what to econmize? Recall Simon's critique of Becker's analysis of change in market workforce participation by women and compare North pp. 84-5. Can price affect the demand curve? Alternative specification of models of inst. change will be taken up again in Period 27 on technology.
c. Path dependence means that history matters. p. 100. (Can you relate to Arthur's concept of a technolgy becoming locked in?)
d. Thus, a common set of fundamental changes in relative prices or the common imposition of a set of rules will lead to widely divergent outcomes in societies with different institutional arrangements. p. 101. (Implications for prescribing policy for the countries in transition from centralized planning?)
e. "One gets efficient institutions by a polity that has built-in incentives to create and enforce efficient property rights. Thus it is hard - maybe impossible - to model such a polity with wealth-maximizing actors unconstrained by other considerations. ...The state then becomes nothing more than a machine to redistribute wealth and income (p. 140)." Where do these culturally derived norms of behavior come from? (Relate to our readings on behavioral economics. If we assume opportunism with guile, we shall never have honest judges.)
5. Where does North stand on seeing institutions as constraints or enablement? Economizing vs. power? Is there any blood or conflict in North's conception? Do we have to choose sides or is transaction grease enough? Can you relate North and Williamson on transaction cost? North speaks of institutions which involve many people while Williamson speaks of bilateral agreements on governance.
We need an institutional behavioral economics of development. North has some suggestions but the task of developing the paradigm to answer his basic question remains. It's a challenge. Are there strong incentives to produce the paradigm or is the academic institutional pattern such that only weak incentives drive the work?
Papers by North on the web http://netec.mcc.ac.uk/WoPEc/data/Persons/49575048494948536879857176658383956795957879828472.html
Review Questions:
1. Develop an SSP chart for that part of North which emphasizes IUG, HEC, and Transaction Costs. Journal file.
2. Develop an SSP chart for that part of North which emphasizes the HIC part of transaction costs. Journal file.
3. Since North is partly impact analysis, use all of our sources of interdependence (situations) to specify institutions which would support economic develoment. Does the theory help identify some areas that North misses? Journal File.
4. For an elaboration of the levels of institutional analysis summrized in C&C p. 302, see Journal File.
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B. No, I do not expect you to read three chapters from Bowles (optional) in addition to North. But, I want you to know what is there for future reference.
Bowles, Chs. 11-13. In Ch. 11, Bowles asks "how do institutions change? And, how do the preferences and beliefs of individuals coevolve with their institutional environments?" Note he discusses the Green revolution and change in customary shares in the Philippines rise harvest that was also noted in C&C 210. You might want to compare his analysis of South African apartheid with that in C&C p. 270. He says it illustrates "the emergence within a society of a large number of individuals who act in ways that violate the convention, eventually displacing it." "The second process inducing institutional or individual evolution is competition among groups governed by differing institutions." 369 These "are best described by an underlying population game that is asymmetrical in both strategy sets and payoffs, different subpopulations occupying different roles in the game." 370 He notes that "distributional outcomes vary among conventions, many equilibria will be Pareto optimal. For this reason, subgroups in the population may have conflicting interests concerning which convention obtains." No kidding! Is this efficiency 1 vs. efficiency 2? He has a place for chance or exogenous developments (such as technology change) collective action of subgroups, persistence over time of inefficient conventions (isomorphic), punctuated equilibria, and preference change of the actors (370-1). "In cultural inheritance processes, behaviors are learned from parents (vertical transmission), or from one's own cohort (horizontal transmission.)" Learning is represented by copying-payoff-based learning, and conformist transmission. 373 Transmission involves "natural selection, group selection, chance and other evolutionary pressures." 373 All of this goes into a formal "replicator dynamic model." His model and experiments supports the Marxian idea that patterns derived from everyday life affect behavior in the Ultimatum Game and others. He models the development of agriculture about 11 millennia ago towards individual claims, particularly in land without formal government. 382 His model includes grabbers, sharers and those who are willing to sanction others even if the result is HEC. Conclusion: preferences are endogenous. Institutions are endogenous. Chapter 12 asks why some institutions are more common than others-i.e. evolutionary universals. He notes certain distributional conventions. He adds, "The introduction of idiosyncratic play removes the deterministic dependence of outcomes on initial conditions…"419 With respect to distribution, he notes that "large numbers of the poor militate against a sufficient fraction of them adopting a nonbest response to displace the equilibrium under which they do poorly (420) "By collective action, I mean the intentional joint action toward common ends by members of a large group of people who do not have the capacity to commit to binding agreements before acting (i.e., they act noncooperativlyl).421." His examples include strikes, ethnic violence, insurrection, boycotts. He does not mention voting. He does not discuss politics or rules for making rules. Why? "Because collective actions generally take the form of n-person public goods games in which the dominant strategy is nonpartipation if preferences are wholly elf-regarding, the extended model must take account of incentives for each to free ride…427"
My conclusion: Once we acknowledge a "positive value of participating" and the role of leadership, we need to talk to people and find out who they are--not much follows from the models themselves. They do suggest some things to watch for. They are a kind of "existence model" showing that there are conditions under which a given performance can result-quieting those claiming a particular outcome is impossible. Whether these conditions actually existed is another matter. (It is an existence model in the same sense as that of Arrow and Debreu's general equilibrium model.)
In chapter 13, Bowles models the emergence of the modern state. "the national state evolved because it won wars with competing organizations, and the ability to win wars depended on its peculiar ability to mobilize soldiers and other military resources. This ability depended on the extent of commerce, the availability of credit, tax compliance, and the willingness to serve rulers in war." 440 This includes the "meteoric spread of Islam in the century following Mohammed's death…441." He describes a process "whereby institutions such as resource sharing and segmentation provide an environment within which a group-beneficial trait evolves, and in which these institutions proliferate in the population because of their contribution to the evolutionary success of the group-beneficial trait (463)." "Altruism and war also coevolved." 467 The variables his theory identifies: conflicts of interest, chance, and collective action, the persistence of inefficient institution, and the highly irregular trajectories of change summarized by the term punctuated equilibria." 468 Are these identified in C&C?
Bowles and the Santa Fe Institute are big on agent based modeling and simulations (as noted in C&C 7.5). If you would like to play with it go to:
http://www.santafe.edu/~bowles/ go to "Artificial Histories"
C&C, Ch 14 contains a SSP chart of theory that helps organize observations on both the impact of alternative institutions and institutional change and both formal and informal institutions? The previous Table 6.19 contains a summary SSP chart just for impact analysis.
Review "40 Concepts to Pass Exams With" and "Paradigm Comparison." and Think.
Review "SSP Impact Methodology." The exam is preparatory for your final paper, so you might as well use the SSP framework to search for the similarities in the variables with different names (clothes) identified by different authors.
SSP, what's in it for me? (Sounds like a chant from a protest group otside my office). It is easy to get lost in the details. When you review for the midterm exam, try to reduce the institutional economics paradigm to its essentials. Be clear on the inherent characteristics of each s