21. The purpose of rules is to make you think before you break them.
Mick Jagger: You don’t always get what you want
L.A. Paul: You don’t always know what you want
In the last post I argued that we need to take a wider view of the value of what we normally call possessions or assets, one that includes less tangible things such as friendships. I emphasised the need to consider the whole range of our connections, whether to people or to things, whether holistically or instrumentally. In this post, I will explore these notions further and, specifically in the context of what works. Which connections do we want and how do we want them to work?
The economist Douglass North is recognised for his work in institutional economics. He developed arguments to support his claims that economies with lower costs of doing business, that is, those that are more efficient, perform better. He further claimed that it was the differences in the institutions or rules that were the critical factors in generating these efficiencies; that the rules of the economic game and the ways in which it is played are just as important as playing the game well. More formally, North defined institutions as “the humanly devised constraints that structure political, economic and social interaction. They consist of both informal constraints (sanctions, taboos, customs, traditions, and codes of conduct), and formal rules (constitutions, laws, property rights)".
How did he arrive at his conclusions? Looking at the history of European economies, he found that small, subsistence economies worked on the basis of personal face-to-face relationships. Behaviour was constrained by a varying mix of authority and restraint. Trust was paramount. The ultimate penalty for breaking trust was to be expelled, to be made an alien. Banishment could mean, quite literally, death. People tended to be largely self-sufficient, and specialisation was limited. The institutions tended to be simple - they didn’t need to be other - and the transaction costs were correspondingly low but the opportunities for expansion were also meagre. Trade tended to be local and outsiders were perceived as difficult to trust.
As trade expanded, the costs of doing business increased. How do you trust people that you don’t know and may only trade with once or occasionally? North’s answer is that you build protective shields. Some take the form of physical protection or enforcement, such as the employment of trusted colleagues and guards for people and property - family members were common choices according to early records - to ensure that the goods flowed in one direction and the payments in the other. Others aim to improve information with developments such as standardisation in measurement, the verification of quantities and qualities and the implications of this information for prices. And so this forms the basis of North’s case. The jurisdictions that solve the core problem of increasing the scope and scale of trade, enabling more specialisation, investment, skill development and innovation in low-cost, low-friction ways, will have a competitive advantage and greater growth and prosperity. In the news today, you will hear economic commentators and the captains of industry talking about certainty and confidence. These are the conditions that underpin a trustworthy trading environment and they are supported by better information and enforcement.
In the early stages of regional trade, institutions remained informal and weak. To develop capital-intensive businesses and industries, more formal, impersonal and highly structured rules were necessary. In general, where the legal framework has enabled trust, more and more effort has gone into information services of increasing sophistication. A good example is the futures markets in agriculture that allowed farmers to get a fixed price for their crops by trading risks with financiers. The same is true in insurance markets more generally.
The World Bank believes that the New Institutional Economics developed by North and others provides the way to help developing countries succeed. But their conclusions about the results of practical efforts to do so are less than unequivocally positive:
This is not a surprise. The institutions that count are a mix of the formal and informal and take years, decades or even centuries to attain their current forms. In addition, many of them are not planned but develop organically.
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Where the institutions of dispute resolution are concerned, Taleb believes that the organic are more important than the planned, concluding: “If you cannot effectively sue, regulate”. Common law has evolved piecemeal but it deals with many problems effectively. Regulations try to codify everything. They become captive to powerful interests and the target of gaming by professionals. Taleb’s example can be generalised further: if you cannot trust enough, contract; if the contract fails, sue; and, if you cannot sue, regulate. Legal disputes are a sign of a breach of trust, of an interpersonal failure. It is better that people act from good character and virtue than from legal or political coercion but the gains to made from trading on a large scale mean that trust in good character is more difficult and even foolhardy. The task is to structure the institutions not only to generate prosperity but also to reinforce and promote good character, at least locally (the character of our trading partners, while not wholly beyond our influence, is largely beyond our control).
Today, in addition to inadequate ways to develop effective institutional arrangements and controlling bad actors, there is a further problem. As I remarked a few weeks ago, when Adam Smith was writing, promoting the wealth of nations was uncontroversial. it appears reasonable in hindsight too. The wisdom of the pursuit of wealth cannot be made with as much confidence now. While billions of people remain poor, distribution of wealth is now a greater problem than its generation. In a sense, our main problem has moved from Mick Jagger’s to L.A. Paul’s: collectively, we are no longer as confident about our wealth creating goals as we were. There is a groundswell of support for the idea that we organise our institutions to promote the survival of ecosystems as well as, or instead of, the headlong rush for economic growth.
So which question makes sense here today? Answer: How do we organise our institutions for ecological and human success? And the first answer to that question is surely that we should be modest in our approach; if the results of our efforts to engineer the much more simple task of organising our institutions for growth have been so mixed, we should guard against overconfidence in this more difficult quest.
I have two general suggestions. One is from Taleb’s brand of negative consequentialism, the opposite of classical utilitarianism; the other is to use the tools of behavioural science.
Why negative consequentialism? Because we are better at understanding what not to do than what we should do. We are built to understand threat better than opportunity, the negative better than the positive. Even though Taleb, the arch-conservative, concludes that If you can’t sue, you should regulate, he also says that some environmental risks would be ruinous if unchecked and that regulation is necessary in such cases. This legislation overwhelmingly takes the form of “Thou shalt not…” We want a strong framework rather than a thicket of regulation; the latter merely serves the powerful and legally inclined in their efforts to game the system.
To provide a pertinent example, we can reform markets to force companies to behave responsibly. Generally speaking, before the 1840’s, the permission to run a large business was specific, explicit and conditional; since the 1840’s, the permission has continued to be conditional, but is now general and implicit. Libertarian economists say that the market is the solution, but it is also part of the problem. I am not proposing that we destroy markets but that they serve the higher purposes that we the people demand of them; namely, survival in the long-term without crowding out some of the virtues in which price does not and cannot play a role. Businesses are creative tools for innovating to solve problems without a central directing hand but they cannot be relied on to provide the values we all hold dear nor to have the restraint to work within those values without a legal framework of rights and responsibilities. The government could make a major impact in pollution control by making it an explicit condition of granting a licence to run a business, and to make the responsibilities bite.
Specifically, in exchange for the privileges of being granted the status of a limited liability company (or any other business format that permits great scale), the owners, and through them the managers, should bear the burden of demonstrating that they are not seriously damaging ecosystems either by the scale or pace or irremediabilty of their actions or inactions. The burden of proof should lie with the companies themselves. The continued status of the business should depend on satisfying this requirement annually. The price to be paid by wilful offenders would be a combination of imprisonment, substantial fines and lifetime bans from business ownership, management or investment, with the option of nationalising the business, with or without compensation.
The use of behavioural tools is double-edged. People don’t like to feel they are being manipulated or controlled but we elect governments to make decisions on behalf of all, whether we like them or not. In addition, one of the main tools in the language of the day is to select the “choice architecture”. Broadly speaking this is a presentational point with real implications. One of the more constructive examples in the UK was a change to opting-out of a pension rather than opting-in. The rational is that the state may not be able to afford sufficiently generous pensions in the future so getting people to save for their own retirements is a wise precaution. Its detractors say that while pension investments have performed well in the past, returns are uncertain, and the state should not be taking decisions for the people. In turn, the behavioural scientists argue that they do not make the decision, rather, they frame it.
Behavioural science can influence environmental choices in the same way. For example, making recycling simpler (which box should I put this in) leads to better overall returns even if secondary segregation must be undertaken at a later stage. There are further quite serious problems for behavioural science to address but more on them in a later post.
To summarise this post, we know that institutions and the rules of the game matter. We also know that structuring decisions to prevent consequential harm is more important than encouraging positive actions. We know that the deeply knit web of norms and rules that we live by is complex and? can take generations to develop and “bed-in”. Finally, we know that the success of our efforts to form them deliberately is quite limited. Some of the things that are of greatest value to us, both individually and collectively, are beyond our full understanding and control. Our institutions are among them, but it is clear that we need them to work for both our survival (and those of the ecosystems that support us) and our prosperity.