THESIS ON ECONOMICS H17 Structural Solutions to Social Traps: Formal and Informal Institutions KAIRE PÕDER PRESS TALLINN UNIVERSITY OF TECHNOLOGY School of Economics and Business Administration Department of Economics Dissertation was accepted for the defence of the degree of Doctor of Philosophy in Economics on April 28, 2010 Supervisors: Prof. Kaie Kerem, PhD School of Economics and Business Administration, Tallinn University of Technology, Estonia Prof. Alari Purju, PhD School of Economics and Business Administration, Tallinn University of Technology, Estonia Opponents: Prof. Katri Sieberg, PhD North American Studies Program Department of History and Philosophy, University of Tampere, Finland Martti Randveer, PhD Research Department, Bank of Estonia, Estonia Defence of the thesis: June 17, 2010 Declaration: Hereby I declare that this doctoral thesis, my original investigation and achievement, submitted for the doctoral degree at Tallinn University of Technology has not been submitted for any academic degree. Kaire Põder Copyright: Kaire Põder, 2010 ISSN 1406-4782 ISBN 978-9985-59-993-8 MAJANDUS H17 Sotsiaalsete lõksude strukturaalsed lahendid: formaalsed ja mitteformaalsed institutsioonid KAIRE PÕDER CONTENTS INTRODUCTION .................................................................................................... 7 Acknowledgements ................................................................................................. 10 1. The Problem ........................................................................................................ 11 1.1. Social traps .................................................................................................. 11 1.2. Coordination problems – the weakest link and total randomization ........... 17 1.3. Iterated games and strategies ...................................................................... 19 2. Solutions ............................................................................................................. 23 2.1. Institutions as structural solutions ............................................................... 24 2.2. Social norms ............................................................................................... 25 2.3. Organizations .............................................................................................. 27 2.4. Evolution of cooperation – change and learning ........................................ 28 3. The Method ......................................................................................................... 29 3.1. Analytic narratives ...................................................................................... 29 3.2. Microapproach – small players constitute change ...................................... 31 3.3. Criticism ..................................................................................................... 32 SUMMARY ............................................................................................................ 34 REFERENCES ....................................................................................................... 38 Appendix 1. “How to Catch a Seal? The Study of Rational Norms of 19th Century Island Communities in Western Coast of Estonia” ................................................. 43 Appendix 2. “Credible Commitment and Cartel: The Case of Hansa Merchant in the Guild of the Late Medieval Tallinn” ................................................................. 69 Appendix 3. “The Lighthouse in Estonia: The Provision Mechanism of ‘Public Goods’” ................................................................................................................... 91 Appendix 4. “The Evolution of Non-Cooperative Behaviour: The Case of Post-Transitional Estonia” .................................................................................... 121 Appendix 5. Elulookirjeldus ................................................................................. 143 Appendix 6. Curriculum Vitae .............................................................................. 149 KOKKUVÕTE ..................................................................................................... 155 ABSTRACT .......................................................................................................... 157 5 6 INTRODUCTION1 The aim of the current overview is to present the connecting features of the four essays which constitute the doctoral thesis. All four published articles are united under a common name, “Structural solutions to social traps: formal and informal institutions,” because they all study institutional solutions to conflict situations, where individual interactions will not reach to the Pareto efficiency. Although each separate article is dedicated to a relatively different set of problems, they all are seeking for solutions to social dilemmas faced by societies or communities. The articles demonstrate how informal institutions, strategic action and evolution of organizations and institutions can solve cooperation problems. Although game theory is becoming an orthodox part of economics’ curriculum, it is still challenging to use games for explaining macro adjustments in society, or to show how micro choices can affect the macro structure. Although it is already known from Smith (1776) that there are systems where individuals neither intend, nor need to be aware of aggregate results – today it is almost common knowledge among economists that there is wide range of such situations (e.g. Schelling (1978) describes situations from marriage to biological evolution). At the same time there is no guarantee that individual choices will automatically lead to the desired social results. For example, Prisoners’ Dilemma (PD) describes situations where individuals are trapped into bad choices. What mechanisms that will help individuals out of these lock in situations is a fascinating question. For the economists this can be as important as the question about sources of long term growth, or it can be that these questions partially are the same. The main contribution of the thesis is the demonstration of different possibilities where institutions change the structure of the game so that social traps can be avoided. In addition, the articles are building a bridge between economics and the neighboring social sciences – most significantly anthropology and cultural sociology. Although this link must not be confused with economic imperialism that some economists (Tullock 1972, Becker 1976) have promoted. The aim of these articles is not the quantification of social episodes, but looking for the areas where modeling can help explain social phenomena where market mechanisms are not present. In studying institutions these parsimonious models can explain institutional or cultural phenomena as complementary mechanisms to the markets. At the same time the dialogue with neighboring social sciences over the validity of the results can be a fascinating area for future research. Institutional research has gained more and more appreciation since North’s (1990) book. Nowadays institutional research is far from the peripheries of economics. North received the Nobel Prize in 1993. Recently in 2009 the Nobel committee awarded Ostrom and Williamson the Nobel Prize for their analyses of economic governance, areas that almost overlap with the analyses in the current theses. In 1 Publication of this thesis is granted by the Doctoral School in Economics and Innovation created under the auspices of European Social Fund. 7 general the New Institutional Economics seeks to explain political, historical, economic and social institutions such as government, law, markets, firms, social conventions, etc. in terms of the Neoclassical economic theory. More particularly the following articles are interested in institutions which may help solve certain cooperation problems. Three articles out of the four use historical narratives, thus the work of Avner Greif (summarized in a 2006 book) has had a great influence on this work. Greif (2006) seeks for the efficient organization that entails the establishment of institutional arrangements and property rights that create an incentive to channel individual economic effort into activities that bring the private rate of return close to the social rate of return. Institutionalists, like Greif or further back in time North and Thomas (1973) and Williamson (1985), believe that if a society does not grow it is because there are no incentives provided for economic initiative. Institutions shape incentives. We, like many other institutionalists, believe that using the methods of economics can contribute mainly to the research of self-enforcing institutions. Although it is also vital to show that in some cases external enforcement is unavoidable, or at least is unavoidable under current technology. However our main contribution is the demonstration that there are some unique examples of institutions that solve the problems of social traps. To place our research in comparative perspectives, it is important to mention that Ostrom (1990) shows similar results in the management of commons in the case of Spain and the Philippines. As already mentioned, Greif et al. (1994) showed similar results in the case of merchant guilds as does our case of the Tallinn Merchant Guild. Our pure public good provision story is in close dialogue with the Coase (1974) article, but reaches different conclusions, although there has been periods in Estonian history