LINEBURG


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building trust. Non-cooperation doesn™t require as much
coordination as cooperation does. Not to cooperate usually means
to withdraw. To cooperate, people must not only trust one another
to do so, they also have to coordinate on a social norm that everyone
understands. That is why it™s a lot easier to destroy a society than to
build it.

How does an increase or decrease in cooperation translate into
macroeconomic statistics? Our numerical example captured a
salient point, that an increase in cooperation raises incomes by
permitting a more ef¬cient allocation of resources: A™s working
capital was put to better use under cooperation, as was B™s labour.
Consider now two communities that are identical in all respects,
excepting that in one people have coordinated at an equilibrium
where they trust one another, while people in the other have
coordinated at an equilibrium where they don™t trust one another.
Economics




The difference between the two economies would be re¬‚ected in
their total factor productivity, which would be higher in the
community where people trust one another than in the one where
they don™t. Enjoying greater income, individuals in the former
economy are able to put aside more of their income to accumulate
capital assets, other things being equal. So GDP growth there is
higher. Mutual trust would be interpreted from the statistics as a
driver of economic growth.


Communities and markets
How did people who now interact with one another get to connect
in the ¬rst place? In Desta™s village the answer is simple: mostly
they have known one another from birth. People engaged in long-
term relationships based on social norms “ communities, for short “
have to know one another, at least indirectly, through people they
know personally. Desta™s father, for example, knows most members
of the iddir to which he belongs. The family know all those with
whom they share the local commons. Communities are personal

46
and exclusive. Members have names, personalities, and attributes.
An outsider™s word isn™t so good as an insider™s.

In contrast, the hallmark of transactions enforced by the law of
contracts is that they can take place among people who don™t know
one another. In Becky™s world, people are mobile, a pattern of
behaviour not unrelated to the fact that they are able to do business
even with people they don™t know. Becky frequently doesn™t know
the salespersons in the department stores of her town™s shopping
mall, nor do they know Becky. When Becky™s parents borrow from
their bank, the funds made available to them come from unknown
depositors. Literally millions of transactions take place each day
among people who have never met and will never meet. Often, the
exchanges take place only once, unlike exchanges based on long-
term relationships. Markets are prime examples of institutions
offering such opportunities. In contrast to communities, markets
are impersonal and inclusive. Witness the oft-used phrase: ˜My
money is as good as yours™.




Trust
Property rights
Property rights to a commodity are the rights, restrictions, and
privileges regarding its use. The subject is central to economics
because it is closely related to the incentives people have to use
goods and services in one way rather than another. Ill-de¬ned
property rights to a commodity usually spell bad news, because no
one is fully able to capture the bene¬ts that can be obtained from it;
which is another way of saying that, all things considered, no one
has an incentive to put the commodity to its most ef¬cient use. For
brevity, we will assume that ownership of a commodity includes (i)
the right to use it in the way the owner chooses and (ii) the right to
exchange it for some other commodity (by selling or leasing it) or to
offer it as a gift.

In talking of property rights, we shouldn™t only mean private
property. There are a number of commodities in Desta™s village that

47
Economics




5. Children gathering fuelwood from the local commons


are communally owned. Desta™s community has historical rights to
them. They are called ˜common property resources™ (CPRs), or
simply the ˜local commons™. CPRs are frequently natural resources
(grazing ¬elds, ponds, woodlands, coastal ¬sheries, mangrove
swamps). But produced goods can be CPRs too. For example,
villagers in the microwatersheds of poor countries have been known
to build catchments that serve both as irrigation tanks and as
¬sheries. The tanks were built and are maintained by collective
effort. They are regarded by villagers as CPRs. Where they are
communally managed, CPRs aren™t open to all, but only to those
having historical rights. As the transactions involving them are
typically not mediated by market prices, their fate can go
unreported in national economic accounts (Chapter 7).

There is, however, a bad piece of news about institutions that
regulate the use of CPRs. Entitlements to products from CPRs
are frequently based on private land holdings: richer households

48
enjoy a greater proportion of the bene¬ts from the local
commons. Access to the more productive bits of CPRs in India
are not infrequently restricted to caste Hindus. That women
are sometimes excluded has also been recorded “ for example,
from communal forestry. Communities can be as ruthless as
markets.

CPRs are to be distinguished from goods to which there is open
access. The latter category consists of commodities that belong to
everyone, meaning that they belong to no one. Except for the case of
knowledge about ˜facts of nature™ (Chapter 5), it is unusual for
someone to produce something and then allow free access to it;
which is why commodities to which there is open access are
typically uncon¬ned natural resources, such as the atmosphere and
the open seas.

Even when ownership isn™t in dispute, it can be that a property is
managed badly. This can happen if, for example, those who own it




Trust
are unable to cooperate (an unmanaged CPR), or if those who
manage the property resort to corrupt practices (in¬‚ating a ¬rm™s
pro¬ts by dubious accounting practices), or if directors of
companies make decisions that are not in the interest of
shareholders. So long as community members don™t discount the
future bene¬ts of cooperation at too high a rate, collective
agreements over the use of CPRs can be made credible by recourse
to social norms of behaviour. Why then do people typically fail to
reach agreement on the use of open access resources? The answer is
that cooperation would involve too many people with differing
needs and intentions. Moreover, as cheaper ways for extracting
natural resources are discovered and economic growth is
accompanied by ever increasing waste material that must ¬nd room
somewhere, the extraction rate under open access increases. These
factors explain why ¬sheries in the open seas and the atmosphere as
a sink for carbon emissions are under severe stress today. Open
access resources are overused, because no one has to pay for the
right to use them.

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Whether ownership is private, communal, or whether it is ˜open
access™ depends in part on the commodity™s characteristics. Mobile
resources are dif¬cult to privatize, but some can be prevented from
becoming open to free access. Communities have been known to
share river water, and coastal ¬sheries are often CPRs. Agreements
are kept either by an external enforcer or by mutual enforcement.
The context matters.

It is no accident that as much as 20% of Desta™s household income
is from the local commons, whereas the CPR in Becky™s
neighbourhood provides households there with the opportunity at
best to picnic. Historical studies tell us that CPRs decline in
importance as economies grow. They decline because the relative
scarcities of goods and services change with economic growth.
Compared to manufactured capital and human capital, land is
pretty much ¬xed in size. Moreover, scienti¬c and technological
advances make available more and more productive uses for land.
Economics




Some people want to develop the land for one set of purposes,
others for other purposes. As it becomes ever harder for
communities to reach agreement over the use of land-based CPRs,
the urge to privatize grows.


Goods and services: classi¬cations
It is good practice to distinguish one object from another if they
happen to be distinct. Goods and services are commonly
distinguished from one another by their physical and chemical
properties (for example, potable water is different from wheat).
People generally acknowledge that goods and services should be
distinguished from one another also by their location, as is implicit
in the disparagement that someone is ˜bringing coals to Newcastle™.
Thus, potable water in the Sahara is a different commodity from
potable water in Alaska. The economist Erik Lindahl showed many
years ago that to make sense of borrowing, saving, lending, and
investing (Chapter 6), we should distinguish goods and services
from one another also by the date of their appearance. As potable

50
water today is a different commodity from potable water tomorrow,
we should acknowledge the difference. It follows from Lindahl™s
account that a durable commodity should be regarded as the stream
of services it is expected to provide over time.

The economist Kenneth Arrow showed that commodities should be
distinguished from one another even more ¬nely. He argued that in
order to make sense of insurance and the stock market, we should
distinguish goods and services from one another also by the
uncertain contingencies in which they appear. It follows from
Arrow™s account that potable water tomorrow in case the weather
will be cold is a different commodity from potable water tomorrow
in case it will be hot.

Planning for the future requires that we make provisions of goods
and services at future dates. When a trader in Becky™s world buys
wheat forward “ that is, he pays now for a bushel, to be delivered in
six weeks™ time, say “ he buys wheat of a certain composition (kernel




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size, moisture content, and so forth), to be delivered in six weeks™
time, no matter what. By storing maize in their home, Desta™s
parents try to ensure that the household is able to consume maize
until near the next harvest, no matter what. In terms of Lindahl™s
classi¬cation, both the trader and Desta™s parents are purchasing
˜dated commodities™. But the future is inevitably uncertain. By
paying an annual insurance premium on their home, Becky™s
parents purchase a replacement for their home during the following
year if and only if their home is damaged. (They don™t get the
premium refunded should their home remain undamaged at the
end of the year.) The commodity they are buying is a home that
replaces the present one during the following year if and only if
their present home is damaged. In Arrow™s terminology, they are
purchasing a ˜contingent commodity™.

Private goods, public goods, and externalities
By a private good economists mean a commodity whose use is both
rivalrous and excludable. Food is a quintessential private good. If

51
someone consumes an additional unit of food from a given amount,
all others taken together will have a unit less to consume (that™s
˜rivalrous™); and so long as the rights to the food someone possesses
are protected, he or she can exclude others from consuming any of it
(that™s ˜excludable™). Most of the goods we consume or use are, in
this sense, private. In sharp contrast, a public good is a commodity
whose use is non-rivalrous and non-excludable. National defence
comes readily to mind. If a nation has the equipment to protect
itself against attack, it not only protects all who live there, it would
cost nothing more to protect anyone else who comes to live there
(that™s ˜non-rivalrous™); moreover, it wouldn™t be possible to exclude
anyone who comes to live there from that protection (that™s
˜non-excludable™). There are public ˜bads™ as well. Ef¬‚uence from
paper mills is a ready example.

Public goods are the mirror image of resources to which access is
open. In contrast to open access resources, which are overused,
Economics




public goods are undersupplied if people are left to their own
devices. The economists Knut Wicksell and Paul Samuelson traced
the reason for that undersupply to the incentives people have to
free-ride on the provisions others happen to make. The point is that
once a public good is supplied, it is a commodity to which access is
open. But the private incentive to supply the good won™t take that
bene¬t into account. Wicksell and Samuelson argued that the
problem can be overcome only by collective action. That action can
take one of two forms: (i) public provision; (ii) publicly subsidized
private provision. Where the geographical reach of a public good is
con¬ned (forest cover in microwatersheds; local sewage systems),
˜public™ may mean the community or the local government. In either
case we are in the realm of local politics. In Desta™s world, local
public goods are usually supplied by the community; in Becky™s,
they are the responsibility of local government. In neither world
does the market take the lead. Where the public good is con¬ned
within a national boundary (national defence), collective action
means state involvement, and so, national politics. When the public
good is uncon¬ned (the global circulation system governing

52
climate), collective action can only mean involvement of the
international community, and so, international politics.

The private provision of public goods confers an extreme form of an
effect known as externalities. By an externality, we mean the effects
that decisions have on people who have not been party to the
decisions. In some cases the effects are bene¬cial (they are known as
positive externalities); in other cases they are detrimental (negative
externalities). Primary education and public health measures confer
positive externalities. If I become literate, I bene¬t; but so do others
who are literate, because they can now communicate with me via
non-oral means. Similarly, if I get inoculated against an infectious
disease, I bene¬t; but so do others who are susceptible to the
disease, because they are no longer in danger from me. Imagine
now that education and inoculation are institutionalized as private
goods. Each household would underinvest in both, because none
would take into account the bene¬ts they would be conferring on
others.




Trust
In contrast, crowding on highways and sulphur oxides in a city™s
airshed involve negative externalities. If you drive your car on the
highway, presumably you bene¬t; but you add to congestion and so
cause others to suffer on the highway. Similarly, when your car
emits sulphur oxides, others living under the airshed suffer a loss.
Each such case involves the free-rider problem, much referred to by
political commentators today. The idea that free-riding and
externalities are related is old. The economist A. C. Pigou noted the
problem in the 1920s and advocated the use of taxes and subsidies,
respectively, for reducing the private supply of negative externalities
and increasing the private supply of positive externalities.

Money
By subsistence agriculture, economists mean self-suf¬cient agrarian
households. Desta™s household isn™t quite like that, but it is close
enough. Becky™s household is very different. Her parents™ income is
used to obtain the goods and services her household consumes. The

53
household does that by trading in the market. If you were to itemize
the number of transactions Becky™s household makes each year, the
vast majority “ consisting mostly of very small items, such as
groceries “ are for immediate consumption. Payments in Becky™s
world are made in money, expressed in US dollars. The notes and
coins that form a part of what goes by the name ˜money™ possess no
intrinsic worth. So why do people hold them? Why do we need a
medium of exchange in the ¬rst place?

Imagine a world where everyone is known to be utterly trustworthy;
where people don™t incur any cost in computing, remembering, and
recognizing people; and where every transaction “ whether here
and now, or across time, space, and uncertain contingencies “ can
be carried out costlessly. In that world people would be able to do
business with one another merely on the basis of their word. There
would be no need for money.
Economics




We don™t live in that world. To see why money is a necessary
medium of exchange in the world we live in, imagine that person A
possesses wheat, person B rice, and person C maize. Let us suppose
also that A likes rice, B maize, and C wheat. Bilateral exchanges of
goods (more commonly known as ˜barter™) would be impossible
because of an absence of what economists call a ˜double-coincidence
of wants™: A wants B™s rice but can™t barter with B because B doesn™t
care for A™s wheat; and so on. The example is stark, but the problem
it poses is very general. The use of money as a medium of exchange
enables people to do business with one another even in the absence
of a double-coincidence of wants. Money is a legal tender in both
Becky™s and Desta™s worlds because the governments in their
countries say it is a legal tender and back that statement with the
power of their authority. Paul Samuelson constructed a model not
dissimilar to the one we studied earlier (of a partnership between
persons A and B) to show that, although money is intrinsically
valueless, people hold money because they want to be able to
purchase goods and services without possessing goods and services
with which to barter. So money is not only a medium of exchange,

54
but also a store of value. Becky™s household wouldn™t be able to
survive if it didn™t live in a monetary economy. Desta™s household,
being nearly self-suf¬cient, could just about survive. However, we
should avoid imputing causality when there is none. If Becky™s
household lived in a place where markets were absent, it too would
try to be self-suf¬cient. The family would be destitute if her father
tried to live on his skills as a lawyer. Of course, even Desta™s parents
need money to purchase the goods available in the few markets that
exist in their village environment. They accept money in exchange
for the liquor Desta™s mother brews and the teff her father grows.

Notes and coins issued by the government are not the only kind of
money in Becky™s world. Business transactions most often use
cheques drawn from one bank to another. As current account
balances also serve as a medium of exchange, they are also money.
When signing a contract, the relevant parties entertain certain
beliefs about the dollar™s future value, by which I mean beliefs
concerning the bundles of goods and services a dollar will purchase




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in the future. Those beliefs are based in part on their trust “ more
accurately, con¬dence “ in the US government to manage the value
of the dollar. Of course, the beliefs are based on many other things
besides, but the important point remains that money™s value is
maintained only because people believe it will be maintained.
Similarly if, for whatever reason, people fear that the value will not
be maintained, then it won™t be maintained. Currency crashes, such
as the one that occurred in Weimar Germany in 1922“3, are an
illustration of how a loss in con¬dence can be self-con¬rming. Bank
runs share that feature, as do stock market bubbles and crashes.
There are multiple social equilibria, each supported by a set of self-

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