WHO GETS WHAT, WHEN, HOW? POWER, ORGANIZATION, MARKETS, MONEY AND THE ALLOCATION OF RESOURCES By Martin Shubik January 2018 COWLES FOUNDATION DISCUSSION PAPER NO. 3018 COWLES FOUNDATION FOR RESEARCH IN ECONOMICS YALE UNIVERSITY Box 208281 New Haven, Connecticut 06520-8281 http://cowles.yale.edu/ WHO GETS WHAT, WHEN, HOW? Power, Organization, Markets, Money and the Allocation of Resources Martin Shubik © Copyright Martin Shubik, 2015 1 Contents Preface Acknowledgments 1 The Emergence of Civilization with Money and Financial Institutions 2 Ownership and the Allocation of Wealth 3 Custom, Law, Markets and Measurement 4 A Preliminary to Understanding Markets and Competition 5 Markets and Minimal Financial Institutions 6 Process and Formal Mathematical Institutional Economics 7 Time and Institutions 8 Uncertainty and Chance 9 Innovation and Ecology 10 Alice in Wonderland and Mathematical Institutional Economics 11 The Summing Up: Economics the Next Hard Science? 12 Political Economy and the Future? A Brave New World? 13 Political Economy, the Future Dystopias, and Space? A Preferences and Utility B The Basic Game Theory Concept of Use Here B.1 Details, Strategies, and Diplomacy B.2 Zero-sum or Nonzero Sum? B.3 Solutions Bibliography Preface Money is a mystery and financial institutions are often regarded as guardians and promoters of the mystery. These sketches are designed to help an individual interested in, but not technically trained in economics, understand markets, money, credit and the evolution of a mass market 2 system embedded in the rich context of its political environment and society. The efficient functioning of a dynamic economy requires the presence of money and financial institutions. The great variety of financial institutions in any advanced economy requires that a synthetic approach is used to understand what the whole looks like. Verbal description provides an overarching view of the mixture of history, law, philosophy, social mores, and political structure that supplies the context for the functioning of the economy. This has been vividly illustrated by Adam Smith, his teacher the Reverend Francis Hutcheson and his close friend David Hume. There are two different but highly allied themes in this single slim volume. Chapters 1, 2, and 3 supply the rich context of history, society, polity and law in which every economy is embedded. Chapters 12 and 13 sketch what might lie ahead given the current state of the world. These chapters require no symbols or technical depth. In contrast Chapters 4 to 11 offers a reasonably nontechnical exposition of some of the considerable development in formal economic theory pertaining to money and financial institutions as economics struggles towards emerging as a science, balancing quantitative measures with qualifications that help to explain what the numbers mean. 3 Acknowledgments I am indebted to many colleagues over a span of 65 years. I thank all, but rather than add a small address book. I let them be mercifully anonymous so that they can avoid all blame for the contents. 4 Chapter 1 The Emergence of Civilization with Money and Financial Institutions Presented here is the sketch of a basis for understanding economic dynamics and the means for social, legal and political guidance of an economy. It can be shown that markets and money are emergent phenomena. They will come into existence regardless of the political structure. However not all goods and services are amenable to distribution by markets. Many public goods and bads exist and a society must devise methods to deal with them. Markets depend on measurement. It is relatively easy to quantify apples for the market; but even there the listing of the number of types, the freshness, the size and quality of the apples pose problems in specifying weights and measures. In contrast the measures of many varieties of pollution such as smog, or noise are far harder to quantify. Even harder and closer to the domain of basic philosophical dispute are items such as the modern versions of Blood Money or payments made to compensate for injury or death. At least since the British utilitarian philosopher Jeremy Bentham there has been an emphasis in economics to introduce the measurement of pleasure and pain. The virtues of measurement have been seen in every science; but it is important to consider that measurement may easily be prematurely imposed on phenomena that are not, given our current state of knowledge, susceptible to the precise quantification required. Many of us in the United States become poll junkies. We have to be fed our daily numbers, be they the poll-of-polls showing Politician A is ahead by 6% over Politician B; or according to the latest World Great Restaurant Poll the world’s greatest restaurant is a little known gem in Bariloche; furthermore recent popular residence polls show that taking all factors into account the best city in the United States for year round living is Terre Haut, Indiana, leading the runner up, Fresno, California, by 23.52%. In a sober mood most of us know that many of these numbers are salesman hype combined with specious accuracy to give them extra authority. We know that popular saviors lie and that hucksters exaggerate; but in getting our daily fix we want to know what the numbers are, not how they were generated and what this means. It is quicker, easier and more fun to supply our beliefs as to what they mean rather than bore ourselves by reading footnotes, or even worse, having to look up documents with technical descriptions. Life is too short to do so. In the United States economy there has been a tendency to try to monetize virtually everything. Oscar Wilde aptly described one of his characters as “a man who knows the price of everything and the value of nothing.” This quip distinguishes between the process of valuation and the outcome of many valuations which may form price. As a good approximation, in every-day life the prices formed in a market for eggs or canned beans do a pretty good job in connecting price and valuation. In evaluating worth of health, cultural heritage, criminal justice, defense, the citizens’ army and many other features of life in a complex society, market price may not exist. The stress in these sketches falls heavily on those parts of the economy where, measurement, 5 market and money all play a critical role. These parts are large enough and sufficiently important to merit understanding as a separate topic from other means to distribute resources; but this must be done with appreciation of the broader context of the society and a feeling for both the qualitative and quantitative aspects of resource allocation. As my aim is to provide an overview moving between the qualitative and the quantitative I provide, on occasion, crude figures or “guesstimates” to sweeten the intuition, as well as direct figures from specified sources. Accuracy is a function of purpose. The precision called for in trying to indicate that there has been a rise in crime in Chicago differs from the precision needed to land a machine on Mars. The approach adopted here calls for getting a rough feeling for some magnitudes that are virtually impossible to obtain quantitatively without a lifetime of statistical and econometric research. Carefully defined data on items such as the world revenue from bribery and extortion do not exist beyond estimates based on a shaky classification. One way in which measurement emerges in a society is that a popular writer, a politician or a special issue partisan promotes and publishes a “guesstimae” based on little more than assertion; this is denied by opponents who cook up guesstimates going in the other direction. If battle is joined partisans call for pundits, pollsters, lawyers, social scientists and other experts and new measures emerge. A goal is to make this book as non-technical as possible consistent with avoiding the dangers of oversimplification of complicated phenomena. In order to do so an understanding of some of the basic concepts of game theory and gaming are helpful. These are presented along with some notes on measurement in appendices. For those who like previews I have presented a preliminary sketch of all following chapters, but for those who prefer to go to the first course without studying the full menu an immediate skip to Chapter 2, should work. Chapter 2 on Ownership and the Allocation of Wealth is an essay unto itself sketching the emergence of a complex human society from the very beginnings. It deals with the basic problem of all life, the acquisition of all resources by every means. The title of this book is a paraphrasing of the distinguished Political Scientist Harold Lasswell’s definition of politics as “Politics is the study of who gets what, when, how.” But it is suggested here that this applies to a far larger stage than politics alone. Politics is only one of the many ways in which resources are transferred. In Chapter 3 entitled Custom, Law, Markets, and Measurement the scope is narrowed considerably, dealing more explicitly with resource allocation by politics, law and economics. In spite of the national (and historical) pastime of telling lawyer jokes, the enormous role of lawyers and the courts in helping to clarify vague categories and provide sufficient measurement in problems where measurement appears to be impossible is considered. Good law is pragmatic and empirical. Chapter 4 called A Preliminary to Understanding Markets and Competition turns towards understanding more precisely the conditions needed for markets to function. A primer is given 6 that explains what game theory is about, why it is important in many aspects of the economy, what are its great strengths and its considerable weaknesses in understanding human affairs.