Tuesday, September 14, 2010

The Significance of Rules

Two years ago when teaching the Economics of Compassion class (for the first time)  I delivered my lecture on the Ten Principles of Economics. When Principle #8 in Common Sense Economics popped up about institutions and technology leading to economic progress my explanation was glossy. Obviously technology would increase the economic possibilities: computer, cell phones, transportation and shipping advances all work to make business easier to conduct. When business is easy to conduct we can trade more (which is good since trade creates value . . . a positive sum game). Lately my thoughts have been focused on technology's less tangible brethren: rules.

Rules, you ask? Rules are the constraints on human interaction and they can either be legal or social. The significance of rules can be seen with the failure and success of micro-loans. When Muhammed Yunus believed that the poor in Indonesia were not bad credit risks and simply needed access to money to improve their irrigation systems he determined to offer them loans. The people defaulted on the loans. Then, he decided to change the rules. First, small groups were formed. Second, loans were given to each person in the small group. Future loans to any individual in the small group were contingent on everyone in the small group paying back their loan. The social pressure generated a strong incentive for each person to responsibly payback their debt. That change in the rule meant a lot to the overall success of Yunus' vision.

There are many other examples of how rules are really important to improved economic activity. Here are a list of rules that could potentially improve economic activity:

1. Is productivity increased when employees are paid in a piece-rate or relative pay scheme?
2. What kinds of covenants will help us avoid the Tragedy of the Commons problem?
3. Do patents stifle innovation since permission must be granted on so many patents for each new invention?
4. What kinds of rules on eBay protect people from retaliation for rating another user in a negative way?
5. What kinds of auditing rules are more likely to deter cheating?
6. Similar question, what kinds of rules about punishment deters criminal behavior? What rules help reform?
7. What kinds of monitoring is needed to ensure welfare recipients are in fact needy?
8. What kinds of monitoring is needed to ensure welfare recipients spend money on the right things? (Food Stamps in Florida now uses plastic cards with picture id that have money placed on them, so that people can't simply trade food stamp dollars)
9. Assembly lines

There are many more examples of the kinds of rules that people develop to help improve economic activity. If you have any other ideas post them up!  

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