Social institutional innovation, like technological innovation, has an evolutionary quality to it: New instruments fumblingly addressing new challenges or opportunities sometimes grow up into highly elaborate systems that take on a life of their own. Market economies in general are an archetypical example of this phenomenon: From places where people came together to exchange their wares, markets have evolved into highly complex and robust networks of global transactions, implicated in a velocity of wealth production and transmission that would have boggled the minds of ancient merchants. Therefore, as we stand on the threshold of inventing new kinds of market instruments which trade in artifacts of administrative regulation, even those of us anchored to the dusty tomes of law and economics might benefit from stretching our imaginations a bit, and contemplating what may lie beyond the horizon.
For the purposes of this fanciful conversation, let’s refer to all present and future market instruments that trade in artifacts of political regulation or aspiration as Political Market Instruments (PMIs). The question posed in this essay, therefore, is: If the challenges involved in current tradable regulatory instruments are increasingly surmounted, and the range of PMIs is extended into other realms, such that the trading of such instruments becomes commonplace, what might such markets evolve into?
In order to explore this question, we need to consider what kinds of goods or services PMIs would commodify. Current and recent uses, including global warming abatement, renewable energy credits, and pollution reduction, are examples of a broader category of challenges called “collective action problems,” which have been discussed extensively, in various forms, in the economic, social scientific, and even mathematical literature (see . Global warming, for instance, invokes the need to create viable international accords through which a preferable global energy and GHG emissions regime can be developed, implemented, and enforced. The challenge emanates from the fact that nations individually bear the costs of contributing to such a regime, but collectively reap the benefits. Simplifying the matter somewhat for this initial discussion, all have an incentive to arrive at an optimal agreement and see it enforced, though all also have an incentive for not complying with the agreement to the extent that they can get away with non-compliance.
Here’s a simple thought experiment which illustrates the nature of collective action problems well enough for the average high school social studies student to understand. Imagine that I make the following offer to a group of thirty people, of which you are a member: For each of you that chooses to pay me $10, I will give each and every person in the group (including you) $1, regardless of whether those other members of the group chose to pay the $10 or not. To avoid discussing any complexities at this point, let’s say that the decision is made in secret, no member of the group ever knows what any other individual member chose to do, and all members agree that their only goal in this exercise is to maximize their own individual wealth. If each individual acts in his or her own rational self-interest, since accepting the offer costs him or her $9, no one would choose to do so. However, if everyone does accept it, each person is made $20 richer. No matter how many people accept or reject the offer, those who chose not to take it will always be better off than those who chose to take it. In other words, rationally doing what best maximizes one’s own individual wealth (in this scenario) leads to an outcome in which everyone does worse than they would have done had they been able to enforce a cooperative agreement.
Real world collective action problems are generally much more complex, in which, just as in market exchanges, there are a variety of comparative advantages (differing concessions or contributions which each is best positioned to make, such as Brazilians being better positioned to offer deforestation reduction, and Americans better positioned to offer industrial CO2 emissions reductions). And they occur on multiple overlapping and nested levels and regarding multiple issues, with myriad collective action problems coexisting intranationally, internationally (among nations as the actors), and transnationally (across national boundaries by non-state actors).
Social institutions arise primarily in response to such collective action problems (and, relatedly, in response to time horizon problems resulting from the devaluation of future consequences leading to insufficient foresight in decision-making processes), and utilize four distinct modalities in order to align individual to collective (and immediate to long-term) interests: Hierarchies, markets, norms, and ideologies. Hierarchies are systems of legitimate authority relying on formally codified and enforced rules. Markets are decentralized systems of multilateral exchange, usually facilitated by some form of currency. Norms are informal rules mutually enforced through decentralized social approval and disapproval. And ideologies are internalized beliefs and values enforced through self-policing and auto-sanctioned by cognitive dissonance (in the form of self-inflicted feelings of guilt or shame). Individual social institutions generally are comprised of some or all of these modalities, usually in combination, developing interdependently both within and across individual social institutions.
PMIs are essentially a hybrid institutional mechanism, comprised primarily of the hierarchical element necessary to regulatory regimes, and the market element which facilitates an efficient allocation of resources and burdens. Governments or international commissions imbue PMIs with their value by creating scarcity (in the case of compliance allowances) or subsidized demand (in the case of off-sets or RECs). The benefit of creating an accounting and exchange mechanism for political concessions and accommodations is the same as creating one for the exchange of goods and services: Like money, it frees actors involved in an exchange from what Edgeworth called “a double coincidence of wants,” that is, the necessity of two actors each having something the other wants more than they want what they themselves have. And, like money, it permits multilateral, geographically and temporally decentralized exchanges among a potentially unlimited number of actors, facilitating the achievement of collectively beneficial arrangements with greatly reduced transaction costs. PMIs are a mechanism for duplicating this innovation in the context of political rather than economic exchange.
Differences among nations, among their individual conditions and priorities, provide opportunities to make political exchanges which help both to facilitate such agreements, and to distribute responsibilities and benefits in accord with each nation’s particular circumstances. The expanded PMI model I am contemplating explores both the potential and the limitations of exchanging political concessions among multiple parties to arrive at mutually beneficial outcomes.
The simplest illustration of the PMI model involves three parties negotiating over three issues. Country A wants a concession from Country C, but has nothing to offer Country C in return. Country B wants a concession from Country A, but has nothing to offer Country A in return. And Country C wants a concession from Country B, but has nothing to offer Country B in return. No bilateral agreement can be arrived at among any combination of these three nations. But if it is worth it to A to make the concession to B in return for the concession from C, to B to make the concession to C in return for the concession from A, and to C to make the concession to A in return for the concession from B, then the three of them can negotiate a tri-lateral exchange that satisfies all of their needs. (In this case, the transaction costs are manageable, and PMIs are not required.)
Similarly, it may be possible at times for numerous nations to arrive at an agreement through such “circular exchange,” under circumstances in which no subset of that group could have arrived at any mutually beneficial agreement. At its most complex (and traditionally most difficult to accomplish, as discussed below), a PMI model aspires to facilitate a tangled web of multilateral exchanges of concessions of varying magnitude implicating numerous unrelated issues, such that the removal of any party to the negotiation or any concession being made would unravel the entire agreement. This frees the parties from the necessity of having bilaterally reciprocal interests, and permits the kind of decentralized, multilateral pattern of exchange typified by markets.
The basic premise of the PMI model is that the more parties and issues that can be conflated in a single negotiation, the more optimal the agreements that can be arrived at through a multilateral exchange of concessions on those issues among those parties. The logical conclusion would be that, therefore, conflating all issues and all parties into a single negotiation leads to the most optimal agreement possible. The limiting factor has been that the larger the number of negotiating parties and issues on the table, the higher the transaction costs of coming to a multilateral, multi-issue agreement. The PMI model, therefore, is currently useful to the extent that it can reduce transaction costs enough that the benefits accrued from the arrangement arrived at exceed the transaction costs spent to arrive at it, and to the extent that there is no other non-PMI-facilitated deal that any subset of the parties could have arrived at which would have given them a better benefit-to-transaction-cost ratio.
This is still an onerous obstacle. However, just as various innovations developed historically to reduce the transaction costs involved in economic exchange (money being the most critical one), the PMI model is not immune to future innovations which might reduce the transaction costs involved, and thus increase the range of its applicability. Such innovation begins with a precise analysis of the anatomy of the transaction costs imposed by political (or contractual) negotiations. The least intractable transaction costs involved in multilateral negotiations are coordination costs: Getting the parties to the table, so to speak. Coordination costs are most salient early in such negotiations, and have been greatly reduced, in international relations, by the proliferation of international institutions and treaties.
Bargaining costs, which involve determining the exact nature of the agreement and the precise division of costs and benefits, are somewhat more significant. Bargaining costs are incurred during the actual negotiation process, when the parties involved try to exchange their way to a multilateral agreement that is satisfactory to each and every one of them. At this stage, the negotiations most closely resemble a traditional bartering market, with all parties both sellers and buyers bartering around a single stall.
Finally, and sometimes most intractably, multi-party agreements are beset by defection (or enforcement) costs. Defection costs are those costs incurred by monitoring and enforcing the agreements arrived at during the negotiations. Improving the salience of the multi-party negotiations, and extending its range of applicability, necessarily involves finding ways to reduce all of the aforementioned transaction costs implicated by it.
The potential benefits of pursuing a PMI approach are myriad. As more activities or concessions are brought into a single market, coordination and bargaining costs are almost eliminated, and even enforcement costs are greatly reduced by creating a much larger shared investment in the integrity of the system. To the extent that successful multilateral political exchange agreements are implemented through it, it increases international interdependence, produces oversight commissions with enough authority to ensure the value of the PMIs, and thus provides an incremental back door into some limited though significant degree of global federalism. To the extent that political market solutions can be implemented, they have strong reverberating effects throughout our integrated social institutional and technological subsystems, creating new markets and new entrepreneurial opportunities, and increasing the ideological and normative association of the development and distribution of sustainable energy technologies with political and economic opportunity in general.
In fact, the development of commissions with the authority to ensure the value of PMIs is both a major benefit and a major challenge. Contractual arrangements within jurisdictions are made possible by a legal structure under which they can be enforced. International agreements are made difficult by the paucity of such enforcement mechanisms on the global level. But international commerce, more than perhaps any other historical force, has integrated sovereign nations into a single interdependent global system. Commodifying political exchange requires more oversight than commercial exchange, but also provides more incentives to create it than traditional international negotiations do, by creating more, and more distributed, opportunities to profit from international political exchange.
Despite the potential for PMIs to improve international and transnational cooperation, they would face all of the challenges already encountered by existing regulatory instruments, and to a far greater extent. The determination of the relative value of seemingly unrelated political concessions would be difficult, but fully established markets are particularly good at accomplishing that (their respective market values would determine their exchange rates). Ensuring the integrity of the instruments (preventing leakage, ensuring additionality, etc.) would grow in magnitude of difficulty as the markets become more multifaceted and extensive (though that could also reduce the problem in the long run by bringing more measurements of more changes in more places into the system). The transaction costs involved in every incremental step in establishing such a market will be enormous.
One benefit of such a comprehensive system is that the universal scope and coverage essentially eliminates the problem of leakage, since there is nowhere for any abated public bad to leak to. Just as the concern about leakage has pushed focus on off-set markets from individual projects to sectoral and nation- or province-wide abatements, it would be one force pushing the expansion of PMI markets in general.
Another obstacle for PMIs, already contemplated in regards to existing instruments, is the perverse incentives they can create. If, for instance, we incorporate deforestation avoidance into international carbon markets, then their value is a creature of past deforestation. When a market values the cessation or reduction of the rate of a destructive activity, it implicitly retroactively values having initially increased the rate of that activity in order to necessitate its reduction. In the context of enduring markets for the abatement of past destructive activity, such perverse incentives pose a serious challenge that must be decisively addressed. Many things we might want to incorporate into future and more comprehensive PMI markets -such as improvement in human rights, military de-escalation, and reduced trade barriers, to name a few- would all have current positive value as the result of the negative value of past or continuing actions and policies. Designing mechanisms to prevent the incentive to create problems in order to trade in their correction would be a fundamental challenge for establishing authentic value-generating PMI markets.
It’s worth noting that in our current international political bartering system, this problem already exists. In the lead-up to international treaty negotiations, countries frequently amp up certain misbehaviors in order to have more to trade with. The increased robustness of PMI markets would only increase the robustness of the problem. And, presumably, at the time of establishment of any new abatement PMI, the baseline set for reduction targets would precede any amping up that may have occurred in anticipation of the creation of such markets.
Stretching our imaginations to the utmost, PMIs could trade in a vast array of political goods. As stated above, there are many public bads that we all have a shared interest in abating: human rights violations, military build-ups, trade barriers, and domestic criminal activities with international consequences (e.g., drug cartels), to name a few. And there are many public goods or broadly shared aspirations that there is either already a shared interest in encouraging, or a potential for some degree of international consensus: improved worker conditions and salaries; more political, economic, and cultural freedom; more open borders; and stronger guarantees of protection for foreign nationals abroad, to name a few. In each case, measures would have to be created (such as a “human rights abuse index”); a target would have to be set for abatement markets (either by reference to a baseline, or by some other aspirational standard) and a system for ensuring the integrity of instruments measuring incremental gains in public goods would have to be established; and monitoring, reporting, and verification systems would have to be in place. As such markets proliferate, the ability to identify and implement new areas amenable to new PMIs would continue to emerge.
Though the notion of trading in human rights abuse abatement, or organized criminal activity abatement, may seem odd, and could certainly raise some moral hackles, it is essentially the same idea as trading in GHG emissions abatement: creating markets for the diminution of some undesirable activity. Given the fact that the obstacles are daunting enough for GHG emissions abatement markets, and that the problems facing them grow exponentially as the scope and coverage is expanded to more issues and parties, the path from the present to this possible future would be a long and tortuous one, with many seemingly insurmountable challenges and as-yet-unforeseen technical innovations defining the way. Whether such a future will ever come to pass is far from certain, but that some future which currently appears equally improbable will come to pass seems almost inevitable (assuming continued human survival).
Such speculation may seem to be an unwarranted flight of fancy from our current vantage point, just as to the ancient Greeks, not unfamiliar with the wonders of the agora, contemplation of the exotic financial instruments being traded today would have appeared equally untethered from reality. The preceding discussion is not intended as a blueprint of how to implement an imminently practicable policy instrument, but rather as an added perspective regarding how to contextualize current innovations in terms of potential long-term historical significance. The question isn’t whether current institutions will evolve to surmount obstacles seemingly insurmountable today, but rather which institutions and in what ways. The lathe of trial and error which will produce those innovations is more productive when we experiment with an eye to future as well as present possibilities. I believe that in a comparison between taxes-and-subsidies and tradable instruments as means for internalizing externalities (specifically carbon taxes and carbon cap-and-trade regulation), while both should be used, each in circumstances most appropriate for it, a less obvious (and perhaps still very slight) added weight needs to be accorded to tradable instruments, due to their dramatic long-term potential for facilitating mutually beneficial cooperation, particularly in the Hobbesian paradise of international relations.
1See, e.g., John Von Neumann and Oskar Morgenstern, Theory of Games and Economic Behavior (Princeton University Press 1944); John Nash, The Bargaining Problem, 18 Econometrica 155 (1950); Garrett Hardin, The Tragedy of the Commons, 162 Science 1243 (1968); and Mancur Olson, The Logic of Collective Action (Harvard University Press 1965)
2See, e.g., Kenneth Boulding, The Economics of the Coming Spaceship Earth, in Environmental Quality in a Growing Economy (Henry Jarrett ed., 1966).
3See, e.g., Garrett Hardin, The Tragedy of the Commons, 162 Science 1243 (1968); and Mancur Olson, The Logic of Collective Action (Harvard University Press 1965)
4I utilized this illustration as a high school social studies teacher, using classroom currency points.
5The actual results in my classroom experiment varied considerably, though there were always some students who accepted the deal and some who rejected it.
6See, e.g., Robert Axelrod, An Evolutionary Approach to Norms, 80 American Political Science Review 1095 (1986); and Elinor Ostrom, Governing the Commons: The Evolution of Institutions for Collective Action (Cambridge University Press 1990).
7Steve Harvey, Institutionalizing the Production of Supranational Public Goods: The Shifting Locus of Interest Group Lobbying in Europe (August 1994) (unpublished paper presented at the annual meetings of the American Sociological Association in Los Angeles, CA).
8F.Y. Edgeworth, Mathematical Physics, (Kegan Paul 1881).
9This is precisely what the famous Coase Theorem postulates. See Ronald H. Coase, The Problem of Social Costs, 3 J.L. & Econ. 1 (1960).
10See Douglas D. Heckathorn and Stephen M. Maser, Bargaining and the Source of Transaction Costs: The Case of Government Regulation, 3 J.L. Econ. & Org. 69 (1987).
11See id.
12See id.
13Admittedly, such discussions quickly run into the issue of cultural relativism v. universal human (and non-human) rights, and the related issue of “imperialism” or hegemony v. cultural and political self-determination, but this issue is implicit in all discussions of international law and international standards of conduct.
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Given my frequent reference to collective action problems (and time horizon problems), along with the endemic levels-of-analysis error committed by right-wing ideologues who insist that individual volition (as opposed to social contracts) should be relied on to produce all public goods, I thought it would be a good idea to have one post to refer to which explains them and their relevance simply and clearly.
Collective action problems are those situations in which a group of people have some public good which they can produce together, or which they must maintain together. Each individual contribution to its production or maintenance costs only the individual making it, but benefits every member of the relevant public. It is often the case that by a strictly self-interested individual calculation, the costs to the individual of contributing to the public good outweigh the benefits to that individual, though the benefits to the group (and thus to all individuals in it) outweigh the costs to the group (and thus to all individuals in it). (Put another way, the total benefits of each contribution outweigh the total costs, but since the individual bears the entire cost and receives only a fraction of the benefit, the costs to the contributor of contributing outweigh the benefits to the contributor).
The classic mathematical formulation of the problem is “the prisoners dilemma” (http://en.wikipedia.org/wiki/Prisoner’s_dilemma). In short, the scenario involves two partners in crime arrested and held in separate interrogation rooms. Each is offered a deal if he turns in the other. Since neither knows what the other will do, they each have to ask themselves what is the best choice for each possibility. If A doesn’t turn B in, then it is in B’s best interest to turn A in, and if A does turn B in, it is still in B’s best interest to turn A in. According to rational self-interest, B’s most logical choice is to turn A in. A faces exactly the same logic. They both turn each other in. But, if they had been able to coordinate their choice, and commit one another to it, they would have both been better off not turning one another in.
There are other classic formulations as well, such as Garrett Hardin’s “Tragedy of the Commons” (http://en.wikipedia.org/wiki/Tragedy_of_the_commons), and “the free rider problem” (http://en.wikipedia.org/wiki/Free_rider_problem).
When I was a high school social studies teacher, I taught my students about collective action problems using the following exercise: Using “classroom currency points” (ccps), I made the following offer to my thirty-or-so students: For each that chooses to pay me 10 ccps, I will give each and every person in the group 1 ccp, regardless of whether they chose to pay the 10 ccps or not. To avoid discussing any complexities at this point, let’s say that the decision is made in secret, no member of the group ever knows what any other individual member chose to do, and all members agree that their only goal in this exercise is to maximize their own individual wealth (the latter being, in practice, what students did). If each individual acts in his or her own rational self-interest, since there is a net cost of 9 ccps to accepting the offer (pay ten and get one back in return, along with everyone else), no one would choose to do so. However, if everyone does accept it, each person is made 20 ccps richer (pay 10, and get one back for each of the 30 students who paid). No matter how many people accept or reject the offer, those who chose not to take it will always be better off than those who chose to take it. In other words, rationally doing what best maximizes one’s own individual wealth (in this scenario) leads to an outcome in which everyone does worse than they would have done had they been able to enforce a cooperative agreement.
Even adding in some of the complexities I left out, communication without any mutually enforceable commitment mechanism doesn’t solve the problem, since each can assure the others that he or she will cooperate but then not actually do so, benefiting from others’ cooperation while not contributing him-or-herself as a result. Some enforcement mechanisms are informal, such as the loss of respect and reciprocal goodwill if non-cooperation is found out; and some are internalized, in the form of values and beliefs in which one feels shame at neglecting to do “the right thing,” and pride at doing the right thing. These are all aspects of the human and social institutional landscape, and all relevant factors in a complete analysis.
Returning to the basic model, it is not hypocritical, for instance, for someone to both support a higher carbon tax and yet not unilaterally pay to the government the amount they think it should be (though calling it “hypocritical” can act as an informal enforcement mechanism in some situations). The carbon tax is based on the calculation that we are all better off in the long run by paying it (and by having our carbon emissions affected by having to pay it), but the choice not to do so unilaterally is based on the calculation that the costs are borne by that individual only, in exchange for a very slight marginal decrease in carbon emissions. Even simply “driving less” faces the same logic: it inconveniences the individual, but does not fundamentally address the problem that is a function of widespread rather than isolated individual behaviors.
The lack of recognition of the difference between advocating for a social policy which incentivizes people to act in a certain way, and choosing to unilaterally act in that way, is an example of a “levels of analysis error,” analyzing social issues as if they can best be understood on the individual level of analysis. This error permeates Libertarian/Tea Party ideology, which doesn’t recognize the existence of public goods, and therefore of collective action problems.
Time horizon problems are similar to, and interactive with, collective action problems. A time horizon problem involves the fact that we quite reasonably value that which will be enjoyed or suffered closer to the present than that which will be enjoyed or suffered farther in the future. One psychological reason is that we cannot be certain that we will survive into that future, so delaying gratification risks never enjoying it, in proportion to how far into the future it is postponed, while delaying something unpleasant means possibly never having to suffer it, in proportion to how far into the future it is postponed. More generally, the present is visceral and certain, while the future is abstract and uncertain. This is why children have to learn to delay gratification, and most adults never get as good at it as would behoove them to be (though some overshoot the mark).
Collective action problems and time horizon problems combine in many instances to create a mutually reinforcing obstacle to widespread cooperation for mutual benefit. The classic example is global warming. Global warming is a global phenomenon, with every emission of Greenhouse Gases (GHGs) affecting the whole world equally (in regards to global warming), but the costs borne by each individual, corporation, and nation that engages in GHG emissions reduction. Compounding this massive, multilevel collective action problem is the time horizon problem: The costs of abatement are in the present, while the benefits lie in the future. Uncertainty plays into these obstacles: Convenient distrust of the overwhelming scholarship demonstrating the reality of the problem is easily mobilized in service to not confronting this combined collective action/time horizon problem.
In the real world, collective action and time horizon problems are nested and overlapping, across levels and among various swathes of shared interests, group identities, or social institutional entities. And the ways in which human minds work, embracing frames and narratives rather than, for the most part, the most rational arguments utilizing the most reliable data, combined with our capacities for empathy and selflessness, complicate the systemic dynamics involved further, creating, along with the multilevel and multisector nature of collective action and time horizon problem, both more complexity in the challenges being confronted, and more opportunity for resolution.
Both biological and cultural evolution are driven, to a large extent, by the combination of collective action and time horizon problems (more the former than the latter). As Economist Robert Frank argues in his book Passions Within Reason, emotions evolved in a certain branch of the animal kingdom in order to facilitate cooperation: The costs of angering others, and benefits of earning their heartfelt gratitude incentivize acting cooperatively. However, genetic and memetic selection occur at the individual level, so incentives to cheat also exist. (Cognitive Scientist George Lakoff, in his book The Political Mind, describes how the mind is “hard-wired,” so to speak, with a capacity for empathy, illustrating the neurological correlary to Frank’s thesis).
Social institutions arise and evolve primarily to augment and improve upon this haphazard function of emotions, with contracts and laws and taking the place of trust, and enforcement by the state taking the place of private retaliation. Four distinct modalities combine in various ways in particular social institution to better align individual to collective (and immediate to long-term) interests: Hierarchies, markets, norms, and ideologies. Hierarchies are systems of legitimate authority relying on formally codified and enforced rules. Markets are decentralized systems of multilateral exchange, usually facilitated by some form of currency. Norms are informal rules mutually enforced through decentralized social approval and disapproval. And ideologies are internalized beliefs and values enforced through self-policing and auto-sanctioned by cognitive dissonance (in the form of self-inflicted feelings of guilt or shame). Individual social institutions generally are comprised of some or all of these modalities, usually in combination, developing interdependently both within and across individual social institutions.
A great deal of theory and research, within a great many different disciplines and paradigms, has explicitly and implicitly been devoted to these dynamics. The complexity involved is, of course, far more extensive than I have indicated in this brief overview. But understanding the basics described in this post should be a requisite part of every human education, for it informs the nature of the challenges we face, and of the solutions available, in essential ways.
(See also The Mathematics of Conflict and Cooperation, for more elaboration of this model.)
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