Ch. 7: Summary
Aaron Swartz
in the silent trade:
> Each traveler ... leaves the goods he has brought ... and they retire to their camping ground. Next day they go back to ... their goods and find opposite them skins of sable, miniver, and ermine. If the merchant is satisfied with the exchange he takes them, but if not he leaves them. The inhabitants then add more skins, but sometimes they take away their goods and leave the merchant’s. This is their method of commerce. Those who go there do not know whom they are trading with or whether they be jinn or men, for they never see anyone.
Herodotus was amazed that "neither side cheats the other ... [they] do
not touch the gold until it is equal in value to the cargo, and the
natives do not touch the goods until the Carthaginians have taken the
gold." Alvise da Ca da Mosto called it “an ancient custom which seems
strange and hard to believe.” But is it really so strange? As Bowles
notes:
> Money is lent in return for an unenforceable promise to repay. ... employees work under contracts that do not even bother to mention that the worker should work hard and well. The contracts signed by residential tenants may include clauses requiring that they maintain the value of the property, but aside from gross neglect, the liability for not doing so is unenforceable. Insurance contracts [can't enforce] prudent behavior on the insured. [Much is spent on] educational and health services, the quality of which is rarely specified in a contract (and would be unenforceable if it were). Parents care for their children with the hope—but no contractual insurance—of reciprocation in their later years. Within the household, couples often implement a quite specialized division of labor and extensive exchange without contractual provisions.
Ours is a world of incomplete contracts and leaps of faith.
But Bowles, as usual, isn't content to preach about this, but has to
model it. (It's this comprehensive impulse that makes the book so
awe-inspiring.) Trades like these are prisoners dilemmas, and yet
obviously not everyone defects. Clearly people have internalized norms
of cooperation, but why? 1) The prisoners dilemma repeats. In a
repeated prisoners dilemma, it makes sense to play nice tit-for-tat
(cooperate in round one and repeat what the other player did
thereafter). 2) People trade with people like them. If we imagine that
cooperators and defectors form groups and trade with others of their
type, then the cooperators will do better off and defectors will want
to become one of them. 3) People develop reputations and people with
reputations for cooperating get more trade.
Another problem is asymmetries. There are information asymmetries: you
know how hard you worked in the past hour, but your boss doesn't. And
strategic asymmetries: the company can make you a take-it-or-leave-it
offer, but you can't make it one. To have a usable contract, both
parties not only need to be able to know all the relevant information,
they have to be able to prove it to a court. Page 252 has a nice table
of alternatives that have been developed in various fields to surmount
these problems (from contingent renewal to security deposits).
Imagine you're selling bottles of wine. The problem is someone doesn't
know if the wine is any good until they buy it, open it, and drink it.
You can't know if the wine is good in advance, but you can adopt a
strategy of not buying it again if it's bad. Both parties are better
off if the seller charges a premium for quality wine -- the seller
because they take the extra money (the rent) home as profit, but also
the buyer because they know that the promise of the extra money in the
future provides an incentive for the seller not to screw them and
provide bad wine.
There are some things to notice about this. First, it's Pareto
inefficient. Second, the seller gets this extra profit even though
there's perfect competition. Third, this pattern is stable even though
it doesn't clear the market. Fourth, the same buyer and seller partner
over time. Fifth, the buyer gets to pick the price. Sixth, the buyer
enforces a psuedo-contract themselves. Seventh, the buyer works to
change the psychological incentives for one particular seller in a way
they usually can't in an anonymous market.
And, obviously, this pattern is applicable to much more than wine.
(Think about employment contracts.)
In the early 1970s, economists began doing experiments on people
trading which, they showed, proved that people followed the Walrasian
model (see ch. 6). This seemed rather surprising to most psychologists
who knew that people weren't perfectly rational. And, indeed, in the
1990s experimenters found sellers in simulated markets generating
extra rents. What explained the difference? In experiments with
complete contracts, the Walrasian model held, but incomplete contracts
generated rents in ongoing relationships, just like our example above.
Thus trust depends on the form of the contract, but it's also true
that the form of the contract depends on whether there's trust.
Imagine that people can choose between perfect and imperfect
contracts. In the case of a perfect contract, they will provide the
minimum level of quality necessary to meet the contract. But in the
case of imperfect contracts, where there's trust, they will provide
higher quality. Thus people might actually be better off having
incomplete contracts!
When contracts can't be enforced, exchange becomes not just a question
of trust but one of power, meaning that even "voluntary" exchanges
raise serious political questions and that cultural and political
questions cannot be separated from economic ones. Instead of a bunch
of individual people trading in competitive markets, we form
organizations (like companies) based on trust and reciprocity and
those organizations sometimes engage in competitive trade. It is to
that world of organizations we now turn.
See you next week.
Aaron Swartz
but this week's chapter really turned me around. This is an incredible
insight which, even more incredibly, I'd never heard before. Plus,
although there's definitely some painful math, on the whole the
chapter is pretty well written and contains a lot of stories and
little bits I couldn't fit into my summary.
Chris Mealy
Aaron Swartz
> view of economics started to click for me, which I hadn't expected (the
> trick is to put the math in plain English: a - d means "the gains from
> cheating a sucker", b - c means "the gains from cooperation", etc).
Yeah, I feel like I have a new sympathy both for the use of
mathematics in economics (not only are the equations beginning to make
sense, but I'm beginning to see how one can learn new things by
playing around with them) but also Marshall's dictum about its use
(namely that one should be able to discover new things by manipulating
equations, but then figure out how to translate those insights back
into English).
> But then chapter 7! You're dazzled by "contingent renewal," right? I sure
> am. It's absolutely amazing to see "quality" in a model! (I majored in econ,
> and aside from "The Market for Lemons" no one ever talked about quality.
> That drove me crazy.) And time! Repeated interactions! Trust! Real-world
> experimental results. And to top it off, an incredible heresy: most markets
> don't clear. It's all coming together now. I'm a long way from having an
> intuitive grasp of it so I hope we see a lot more about contingent renewal
> and its strange properties.
Yeah. It's always struck me in that kind of naive normal person way
that the model of perfect competition doesn't apply to much beyond the
most basic commodities. It's pretty hard to find a bunch of identical
products sold at the grocery store at their marginal costs. But
economists seemed adamant in ignoring this that I figured it couldn't
have been such a big deal.
But here's Bowles coming along, not only saying it's exactly as
important as it seems, but it's totally modelable under very standard
economic assumptions. I don't want to exaggerate, but it reminds me a
lot of Keynes and unemployment. And the analysis of how economics
created commodities with perfect competition to match the theory
reminded me a bit of _An Engine, Not a Camera_.