The Fundamental Problem

1
The Fundamental Problem

• Michael C. Munger
• Earl D. McLean Professor
• Departments of Political Science,
• Economics, and Public Policy
• Duke University

2
Get Some Questions Out of the Way

• I have no idea why
• flammable and
• inflammable are
• synonyms
• No, it is NOT a perm.
• Yes, I have proof.

3

• Mark put up one of his books
• I dont want to be outdone.
• So, here is.
• One of Marks books

4
The Fundamental Human Problem

• The fundamental human problem is the design, or
  maintenance, of institutions that make
  self-interested individual action not
  inconsistent with the welfare of the community.
  (Munger, 2000)

5
The Fundamental Human Problem

• The fundamental human problem is the design, or
  maintenance, of institutions that make
  self-interested individual action not
  inconsistent with the welfare of the community.
  (Munger, 2000)

6
The Fundamental Human Problem

• The fundamental human problem is the design, or
  maintenance, of institutions that make
  self-interested individual action not
  inconsistent with the welfare of the community.
  (Munger, 2000)

7
The Fundamental Human Problem

• The fundamental human problem is the design, or
  maintenance, of institutions that make
  self-interested individual action not
  inconsistent with the welfare of the community.
  (Munger, 2000)

8
The Fundamental Human Problem

• The fundamental human problem is the design, or
  maintenance, of institutions that make
  self-interested individual action not
  inconsistent with the welfare of the community.
  (Munger, 2000)

9
The Fundamental Human Problem

• The fundamental human problem is the design, or
  maintenance, of institutions that make
  self-interested individual action not
  inconsistent with the welfare of the community.
  (Munger, 2000)

10
Two Approaches

• Madisonian
• Ambition must be made to counteract ambition
• Rousseauvian
• Transform the self, solve the problem of amour
  propre. Inscribe the law on the hearts of men.
  Some preferences are better than others.

11
Project 1Madisonian Approach

• Perfectability of Institutions through Mechanism
  DesignAdam Smith, James Madison, John Stuart
  Mill, F.A. Hayek, Robert Nozick, and others have
  contributed to this point of view. It works like
  this take self-interest as given, with
  interests themselves exogenous. Then try to
  design mechanisms (with markets being one
  archetype) where the collective consequences of
  individual self-interest are not harmful, and may
  even, led by an invisible hand lead to a better
  world.

12
MadisonFederalist 51

• The great security against a gradual
  concentration of the several powers in the same
  department, consists in giving to those who
  administer each department the necessary
  constitutional means and personal motives to
  resist encroachments of the others. The provision
  for defense must in this, as in all other cases,
  be made commensurate to the danger of attack.
  Ambition must be made to counteract ambition. The
  interest of the man must be connected with the
  constitutional rights of the place. It may be a
  reflection on human nature, that such devices
  should be necessary to control the abuses of
  government. But what is government itself, but
  the greatest of all reflections on human nature?
  If men were angels, no government would be
  necessary. If angels were to govern men, neither
  external nor internal controls on government
  would be necessary. In framing a government which
  is to be administered by men over men, the great
  difficulty lies in this you must first enable
  the government to control the governed and in
  the next place oblige it to control itself.

13
Project 2--The Rousseauvian Approach

• Project 2Rousseauvian Approach Perfectability
  of humans in societies, through moral education.
  This is the project that makes culture relevant.
  We spend much of our time, in schools, churches
  and around the dinner table, trying to instill
  values in our children. The reason is that
  self-interest may be malleable, especially in
  the young. But this is very different from an
  institutional design that imposes external
  constraints in the forms of laws and punishments.
  Moral perfectability means that law and morals
  cannot be external constraints. We must inscribe
  the laws on mens hearts. In this view, the self
  is reconceptualized intersubjectively, with a
  focus on the notion that each of us is imbedded
  in a larger context, with ties to each other and
  to the larger good.

14
Democracy Unbound.Rousseau

• But it is asked how a man can be both free and
  forced to conform to wills that are not his own.
  How are the opponents at once free and subject to
  laws they have not agreed to?
• I retort that the question is wrongly put. The
  citizen gives his consent to all the laws,
  including those which are passed in spite of his
  opposition, and even those which punish him when
  he dares to break any of them. (From The Social
  Contract)

15
Democracy Unbound.

• When in the popular assembly a law is proposed,
  what the people is asked is not exactly whether
  it approves or rejects the proposal, but whether
  it is in conformity with the general will, which
  is their will.
• When therefore the opinion that is contrary to my
  own prevails, this proves neither more nor less
  than that I was mistaken, and that what I thought
  to be the general will was not so.
• If my particular opinion had carried the day I
  should have achieved the opposite of what was my
  will and it is in that case that I should not
  have been free.

16
Loyal Opposition?

• This conception of democracy is logical. The
  actions of government are driven by the people
  the general will is sovereign. Opposition to the
  general will is treason, and must be punished.
  No need for two parties only one general will.
• All those countries with Peoples Democratic
  Republic of ___ were not perversions of
  democracy, but examplars. That is what pure
  democracy, with no limits on scope, looks like.
  Cannot be otherwise.
• Democracy, in and of itself, is an attractive
  concept that must constitute a recipe for
  tyranny, unless the scope of collective
  sovereignty is strictly limited.

17
Che Guevaras Man and Socialism in Cuba (1965).

• Society as a whole must become a huge
  school....We can see the new man who begins to
  emerge in this period of the building of
  socialism. His image is as yet unfinished in
  fact it will never be finished, since the process
  advances parallel the development of new economic
  forms. Discounting those whose lack of education
  makes them tend toward the solitary road, towards
  the satisfaction of their ambitions, there are
  others who, even within this new picture of
  over-all advances, tend to march in isolation
  from the accompanying mass. What is more
  important is that people become more aware every
  day of the need to incorporate themselves into
  society and of their own importance as motors of
  that society

18
The Problem.

• The nature of exchange gains from trade. Both
  are better off.
• But only if the exchange takes place
  transactions costs are the ex ante costs of
  negotiating and measuring, and the ex post costs
  of enforcing. Transactions costs can overwhelm
  the potential gains from exchange.
• Institutions and cultural beliefs closely
  related to "common knowledge" problem in game
  theory. Shared meanings, iconography, language,
  symbols.

19
The Problem.

• Closely related to Zaks problem of trusting
  strangers. Norwegians trust OTHER NORWEGIANS.
  But then not really a stranger some shared
  experiences. Shared culture expands the set of
  people I know, and can trust.
• If you drop a wallet in Oslo, sure it gets
  returned. But if Norwegians see THIS man..
• they would hide
• their daughters!
• No trust, because NO
• Shared cultural cues

20
The Problem.

• Flip side institutions and culture can also
  entirely block progress, lock in institutions
  that are not Pareto optimal.
• Consequently, cultures have two properties
• Some are objectively better than others
• They persist, and are very resistant to change

21
Voluntary exchange preconditions require
justice

• For an exchange to be voluntary in any
  interesting sense, the preexisting distribution
  of wealth and power must be just, or morally
  legitimate
• These conceptions are culturally determined.
• I have a gun, you have a wallet.
• Now, I have a gun AND a wallet.

22
What is Dishonesty?

• When does something count as dishonesty? When
  am I cheating? When do I incur negative moral
  judgments of others in the society?
• What matters more, external enforcement and
  threats of punishment, or our internal
  psychological reactions to shame/guilt?
• ANSWER No society that relies on external
  enforcement of all contracts could possibly be
  productive or prosperous.

23
Paradox of Human Affairs

• Rationally, we should all want to be able to
  commit to acting irrationally
• I will not steal from you, I will not kill or
  beat you.
• You make the same promise to me.
• Hobbes Problem Too much liberty. We must
  either (a) make a personal, credible commitment
  of forebearance or (b) make a collective,
  credible commitment to accept punishment from an
  external enforcer
• Much cheaper to use (a). Is it possible?
  Essentally a restatement of the FHP can it be
  solved this way?

24
Trust Game
25
An Example of Cultural Difference

• shibboleth--The word is often combined with the
  word cultural.
• Its general meaning is an unspoken but shared
  understanding of something that identifies
  insiders, and distinguishes outsiders because
  they do not share this understanding.
• Origin The Hebrew word ????? , meaning a
  torrent, a flooding stream or an ear of grain.

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Shibboleth

• Judges 12, 5-7, King James 21st Ed. Bible5   And
  the Gileadites seized the passages of the Jordan
  before the Ephraimites and it was so, that when
  those Ephraimites who had escaped said, "Let me
  go over," that the men of Gilead said unto him,
  "Art thou an Ephraimite?" If he said,
  "Nay,"6   then said they unto him, "Say now
  Shibboleth." And he said "Sibboleth," for he
  could not frame to pronounce it right. Then they
  took him and slew him at the passages of the
  Jordan and there fell at that time of the
  Ephraimites forty and two thousand.
• Imagine twins, separated at birth. One raised
  Ephraimite, and the other raised Gileadite.

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My Definition of Culture

• Culture The set of inherited beliefs,
  attitudes, and moral strictures that a people use
  to distinguish outsiders, to understand
  themselves and to communicate with each other.

28
My Definition of Culture

• Does a completely isolated people have a
  culture?
• We inherit culture from the people we grow up
  with. But it is hard-wired in the set of mental
  connections we create around certain
  relationships we see in the world around us.
• Different cultures pose different answers to the
  FHP. And some of those are better than others.

29
Move from the Trust Game to Versions of the PD

• Prisoners Dilemma is the generic cooperation
  problem. Overused, overly simplistic, but
  illustrative.
• Two ways out external enforcement, which
  changes the payoffs
• Internalize collective welfare, changing the way
  I value the payoffs.
• Mathematically identical, but fundamentally
  different in terms of the nature of the solution

30
Prisoners Dilemma
(note Payoffs are of the form (Row, Column),
and rankings are ordinal, with 1 best and 4 least
preferred)
31
Prisoners Dilemma with Enforcement Defectors
are Tortured
(note Payoffs are of the form (Row, Column),
and rankings are ordinal, with 1 best and 4 least
preferred)
32
Prisoners Dilemma with Guilt Defectors Feel Bad
(note Payoffs are of the form (Row, Column),
and rankings are ordinal, with 1 best and 4 least
preferred)
33
Say AgainCulture Is Inherited

• I have put quotations around the word inherited
  above, not because I am quoting anyone, but
  because the sense of the word is strained. Hair
  texture, eye color, general buildthose sorts of
  things are inherited. They are hard-wired into
  the genetic structure of humans, and children are
  directly and entirely the product of their
  parents. Culture is obviously not inherited like
  this. We teach it to our children, or they learn
  it by tacit and perhaps unconscious exposure over
  time. But it makes sense to think of culture as
  an inheritance, or legacy from the past.

34
Say AgainCulture Is Inherited

• Perhaps more important, different cultures rely
  on different mixes of shame, or guilt, or
  external enforcement, to reduce the transactions
  cost of exchange and to encourage cooperation.
• All cultures are answers to the FHP, but some
  cultures are better answers than others
• Any culture must be locked in. If it is plastic
  and adaptable, it is not a credible commitment.
  The culture may honor adaptation, but the culture
  itself must be relatively stable and unchanging.

35
Origins Two ConceptsDesign or Maintain

• Spontaneous Order
• Intelligent Design
• Does order imply design? Strange disconnectMany
  people who believe fervently in evolution in
  biology insist on the need for design and control
  in social and economic settings.

36
Choices Emerge.Do Preferences?

• Is there some evolutionary process that governs
  preferences?
• Are human moral systems, cure for dishonesty,
  getting better over time?
• The key difference is the absence of any feedback
  mechanism by which the merits of the emergent
  order might be judged, or subjected to
  modification. Douglass North makes this point
  quite forcefully

37
Competition and Feedback

• Efficient markets are created in the real world
  when competition is strong enough via arbitrage
  and efficient information feedback to approximate
  the Coase zero transaction cost conditions and
  the parties can realize the gains from trade
  inherent in the neo-classical argument.
• But the informational and institutional
  requirements necessary to achieve such efficient
  markets are stringent. Players must not only have
  objectives but know the correct way to achieve
  them. But how do the players know the correct way
  to achieve their objectives? The instrumental
  rationality answer is that even though the actors
  may initially have diverse and erroneous models,
  the informational feedback process and
  arbitraging actors will correct initially
  incorrect models, punish deviant behavior and
  lead surviving players to correct models.
  (North, 1993).

38
Order vs. Design Which is Culture? Which is
Better?

• CoyoteEvolution
• Dachshund / ChihuahuaSurvival
• DandelionEvolution
• RoseSurvival
• Wild TurkeysEvolution
• Domesticated TurkeysSurvival

39
My Choices, Your Alternatives

• The essence of social spontaneous order
• Individuals, acting of their own volition, will
  do things that (1) accomplish the ends of those
  individuals, and (2) do not violate the
  expectations of other people in the society.
• It is tempting to think that spontaneous orders
  also have good normative properties, but this is
  by no means obvious. Well-functioning market,
  does have good normative properties, in the sense
  that individual self-interest is consistent with
  the public good. But such consistency between
  individual choices and aggregate consequences is
  not assured.

40
Emergence of Culture David Hume has Lunch at
Café Hayek

• Three claims
• Order requires only regularity and consistency.
  Human beings choose actions based on moral
  conceptions, but also incentives and calculated
  gains that accrue to one action rather than
  another.
• Purposive Action I am going to adopt the
  convention that humans act purposively. I didnt
  say rationally, mind you.
• People choose actions that they believe (rightly
  or wrongly) will lead to a goal that they
  consider (rightly or wrongly) desirable.

41
Culture, Manners are Conventional

• Acting purposively, on its own, is neither
  ethically good nor bad. It just is. From what
  do our judgments arise about whether an action is
  morally laudable, or detestable, or perhaps
  neutral?
• My answer is that given by Hume (for example, in
  Treatise of Human Nature, bk III)These labels
  are entirely conventional what is culturally
  acceptable in one society might be appalling in
  another.
• Manners differ broadly, showing internal
  consistency (that is, people in a society all
  recognize good manners, though they may violate
  them), but may be sharply inconsistent across
  nations (a person acting according to what his
  society considers acceptable manners may
  profoundly offend someone from another society.)

42
Manners

• I've always followed my father's advice He told
  me, first, to always keep my word and, second, to
  never insult anybody unintentionally. If I insult
  you, you can be gddmned sure I intend to. And,
  third, he told me not to go around looking for
  trouble. (John Wayne, 1909-1979)

43
The Problem.

• The nature of exchange gains from trade. Both
  are better off.
• But only if the exchange takes place
  transactions costs are the ex ante costs of
  negotiating and measuring, and the ex post costs
  of enforcing. Transactions costs can easily
  overwhelm the potential gains from exchange.
• Institutions and cultural beliefs closely
  related to "common knowledge" problem in game
  theory. Shared meanings, iconography, language,
  symbols.
• But also may entirely block progress, lock in
  institutions that are not Pareto optimal.

44
Is There an Analogous Feedback Mechanism for
Preferences, for Moral Beliefs?

• That is, if some preferences are better than
  others, IF some moral systems are better than
  others, is there any process of natural
  selection, or conscious design, that would lead
  toward the good?
• Is evolution in human institutions in pursuit
  of a telos?

45
Argentinaness v. Taiwanicity

• "Economic policy is not a random variable that
  varies freely across countries. Rather, policy is
  the result of deliberate and purposeful choices
  by individuals and groups, who have specific
  incentives and constraints. If we maintain that
  it is policy differences that explain growth
  differences, what we ultimately have to explain
  is why these deliberate and purposeful choices
  differ systematically across countries. To us,
  the most promising avenue toward such an
  explanation is to be found in the study of
  political incentives and political institutions.
  (Persson and Tabellini 19925)

46
Pooled Growth Regression Observations
Growth Rate
Economic Resources per Unit Time
47
Pooled Growth Regression Regression
Growth Rate
Economic Resources per Unit Time
48
Pooled Growth Regression Taiwan in Red
Growth Rate
Economic Resources per Unit Time
49
Pooled Growth Regression Argentina in Red
Growth Rate
Economic Resources per Unit Time
50
Problem Serial Correlation?

• Taiwans growth is consistently under-predicted
  in an aggregate model
• Argentinas growth is consistently overpredicted
• So errors exhibit serial correlation. Should we
  correct for that?
• Cant correct for specification error! Omitted
  variable is culture, the variable that conditions
  how economic resources are translated into
  growth, output and prosperity.
• Growth models ignore transactions costs,
  commitment problems

51
Will Culture Disappear?

• Ronald Heiner (1983) argues that as human
  interaction becomes more complex and uncertain,
  successful social institutions must reduce the
  information needed to achieve cooperation among
  individuals.
• A persons overall behavior may actually be
  improved by restricting flexibility to use
  information or to chose particular actions (p.
  564).
• Mom and Pop hardware store vs. Walmart
• Farmers Market vs. Piggly Wiggly

52
Limiting Choice Improves Cooperation

• What is the cheapest way of achieving
  cooperation? Formal rules and external
  enforcement, or culture and shame/guilt
  enforcement?
• Heiner (1983)
• In general, further evolution toward social
  interdependence will require institutions that
  permit agents to know about successively smaller
  fractions of the larger social environment. That
  is, institutions must evolve which enable each
  agent in the society to know less and less about
  the behavior of other agents and about the
  complex interdependencies generated by their
  interaction (580 emphasis in original).

53
But will our minds allow this to take place?

• Aspirin
• Food
• In-group vs. out-group perceptions of benefits
• Special snowflakes All of us are unique and
  special..
• Grocery store loyalty cards actually give
  private information about ourselves, because it
  makes us feel special (!)

54
But will our minds allow this to take place?

• Why do people hate Wal-Mart? If you go there,
  you wont find many college professors shopping.
  It is not helping us. It is not FOR us.
• The expansion of Wal-Mart over the 1985-2004
  period significantly reduced consumer prices. The
  expansion of Wal-Mart was associated with a
  decrease of 9.1 in food-at-home prices, a 4.2
  decline in commodities (goods) prices, and a 3.1
  decline in overall consumer prices as measured by
  the Consumer Price Index (CPI).
• Wal-Mart generated savings for consumers through
  several channels, including higher levels of
  capital investment in distribution and inventory
  control assets, lower import prices, and greater
  efficiency in its whole supply chain.

55
Why Do We Hate Wal-Mart?

• Consumer Savings by Income Class 2004
• All Low 20 2nd 20 3rd 20 4th 20
  Hi 20
• Income 54453 9618
  24102 41614 65100 132158
• Spending 43395 17837 27410
  36980 50974 83710
• WM Savings 1345 553
  850 1146 1580 2595
• WM Saving/Inc 2.5 6.0
  3.5 2.8 2.4 2.0

56
Why Do We Hate Commerce? Is it because we hate
merchants?

• This mean and despicable idea which they had of
  merchants greatly obstructed the progress of
  commerce. The merchant is, as it were, the mean
  between the manufacturer and the consumer. The
  weaver must not go to the market himself, there
  must be somebody to do this for him. This person
  must be possessed of a considerable stock, to buy
  up the commodity and maintain the manufacturer.
  But when merchants were so despicable and laid
  under so great taxations for liberty of trade,
  they could never amass that degree of stock which
  is necessary for making the division of labour
  and improving manufactures.
• Adam Smith, Lectures on Jurisprudence

57
Why Do We Hate Commerce? Is it because
factories make pin heads?

• Accordingly we find that in the commercial parts
  of England, the tradesmen are for the most part
  in this despicable condition their work through
  half the week is sufficient to maintain them, and
  through want of education they have no amusement
  for the other but riot and debauchery. So it may
  very justly be said that the people who clothe
  the whole world are in rags themselves. Adam
  Smith, Lectures, pp. 256-7