4. Socio-Economics : Trust, Information & Transactions

Disclaimer: I have never formally studied Economics. These are simply some thoughts on socio-economics.

Quick Terms & Explanations

Economics

Economics is the study of transactions between people or groups of people. Why are there transactions? Because we are eusocial and no one can fulfill his or her needs without others. A person can only fulfill a part of their needs, and concomitantly a part of others’ needs. Crudely, the study transactions to fulfill needs is economics.

What is a market?

Any space where goods or services are exchanged, sold or bought is a market.

How is value created?

Value is created by human labour. Otherwise stated, all “useful” labour creates value. That value is then stored in the product of that labour, which can be exchanged for the product of others’ labour.

What is money?

Money is an emergent phenomenon. When the transactions begin to occur (Debt, Graeber (paraphrase)) between parties who do not know each other and cannot lay a foundation for trust, money emerges. Money refers to a physical object which represents arbitrary value. Thus, a paper note can be exchanged for a certain amount of value. Value as discussed previously, is the product of labour.

How does value change relative to money?

As economies develop, work becomes increasingly specialized. This is because the complexity and diversity of work required to fulfill needs increases. People develop a larger, deeper variety of needs as economies advance, and labour must specialize in order to develop the necessary expertise to satisfy this. In parallel with advances, the value of labour increases. Thus, the value of labour relative to money can increase. As specialization increases, the labour is more valuable in comparison to unspecialized work. This is why life in advanced economies is good, because the labour is valuable and can be exchanged to obtain a large amount of goods/services and thus fulfill needs to a greater degree.

Why does economics necessitate a discussion of sociology?

You cannot study economics in isolation. Sure, you could try describing economic systems and markets. However, the moment economics becomes prescriptive, we need to know what to optimize for. And that requires us to study society. For example, advocates of the free market assume that markets reduce efficiency and fulfill human need and that automatically translates into human progress. When does need-fulfillment and market efficiency translate into human progress? A very quick and dirty example, markets mean you can buy all the fatty food and soda you want on the cheap. This is great need fulfillment, but we need to understand the social context to decide if this si progress.

Money & Trust

It’s interesting to see how transactions initially worked on trust in human society. You exchanged goods on credit because you the other party trusted you. However, now, because market and social complexity prevents knowledge of the other party, we use money, legal guarantees and contracts to enforce transactions and replace trust. This leads to an automatic reliance on the market as the solution to problems. However, the basis of a transaction is always trust. When you pay for a car, you have no way of knowing if the car is defective or not. You trust the car manufacturer to manufacture a good car. You pay the car manufacturer money because you trust that you are getting a thing of value. But you have no real way of knowing if you can trust an unknown party like a car manufacturer. Thus, you have legal contracts and rights that replace trust. This means you need to have a justice system, a system of legal recourse, a contract and an entire host of associated machinery that imposes a significant overhead and cost.

On the other hand, take a simple trust based transaction. You buy the same car off a friend. There is no legal contract, or enforceability needed. You know exactly what you’re getting, and you know nothing is hidden from you. There are no overheads of a legal system, or agreements. Nor do you need to vet the car or perform research. The transaction is quick and efficient. Thus, trust-based transactions are the most efficient.

To clarify, it is not entirely trust based. Were it entirely trust based, you would get the car for free with the understanding your friend could call upon you for a favour arbitrarily and you would fulfill it. Here, in both cases you paid money. The difference being the system of enforcement was unnecessary in the second case. Further, a trust based transaction will never, ideally, carry the risk of fraud. A purely monetary transaction does and, if fraud is committed, will lead to due process which is costly in terms of time, money and imposes a burden on society of conducting justice.

The question then is – why don’t trust-based transactions dominate? As you know, it’s because trust takes simply too long to establish. It isn’t efficient. To conduct trust-based transactions, you would have to spend copious amounts time establishing mutual trust with the other party before you could transact. Monetary, enforceable transactions are far quicker and efficient, especially if the rate of fraud is low such that the justice system is not clogged.

However, historically, human society has been dominated by credit and trust-based transactions. It is only recently that enforceability has come into play. This is a result of the immense infrastructure that a justice system requires. It requires an authority that has the means to enforce. This authority must have immense resources at its disposal and vast reach such that offenders cannot escape. This system must be in place before transactions can switch from trust to enforceability.

Information Deficits

Can trust ever make a comeback? Seeing that trust based transactions are most efficient, are there ways to reduce the initial time of trust deficit and build trust instantly? What are the requirements for trust? The requirement for trust is information. It comes down to observing the conduct of the party over time in varying circumstances to establish a record of behaviour. Or, alternatively, you can receive an opinion on the party from another party you already trust. This is what aggregation websites do these days. They aggregate user opinions to build a picture of trust of a certain identity. Which means we can use technology to outsource the process of trust creation to users in general and overcome the information deficit. It is worth examining how trust might be built by leveraging technology to make for more efficient transactions. That trust is essential to humans is evident in user ratings systems on websites, in car ratings guides, in how people value referrals for candidates over unknown faces. Trust is the basis of transactions, not money. Money is an ersatz basis. You trade trust and certainty for efficiency. Justice is punishment for breaking trust, to intimidate potential offenders into good behaviour.

This information deficit gets at the heart of the idea here. The very reason you buy a product is precisely because you cannot make it yourself. Thus, you do not have the means to evaluate the product either. When you buy a car you have no way of knowing whether the car is good. What if it isn’t? Then you are subject to a costly and time consuming process of litigation. How might there be ways to avoid this? The classic answer is that every market contains feedback mechanisms. What this means is others have bought the car and generate feedback on the car in question. However this still raises the issue of generating this information and conveying it. It also calls in question the need for good information, that is accurate. Another method is that of regulation and inspection, where an authority regulates and inspects the cars to ensure quality and protect the consumer. This second method is prevention while the first method is cure. In this second method, you surmount the information deficit by outsourcing trust to an entity that you know has your best interests, or at the least, has no reason to cheat you.

The need for Regulation

Assume you’re buying bread. How do you know what bread to buy? People say,”Read the label”. So you flip the loaf over and read the label. You see a host of details jump out. Let’s focus on the simplest, most understandable ingredient – wheat. I personally have seen whole wheat, bleached/unbleached wheat, enriched wheat and I’m sure there are more. Now how do you know what is good for you and what isn’t? Do you go read journal articles on each type? Get a Masters degree in food nutrition? And that’s just one ingredient. What about the rest? And what about the nutritional information? Do you educate yourself on every single item? How do you judge? You clearly can’t. If you can’t judge, you cannot establish trust. You need a third party you trust to judge for you. This is where regulators and laws come in. They are a necessary evil. If we could do without them, it would be great. Too bad we can’t.

Trade-offs

You can’t have too much regulation because regulators impose their own overhead, slow down the market, and affect innovation. There is some sort of trade-off involved in regulation versus the free market, and you have to strike a balance, where you say that the increase in regulation would actually harm the consumer by affecting product innovation and time to market, while imposing tax costs to pay for the regulation and enforcement of the regulation itself.

Take a few more examples of information scarcity and parsing difficulties. You never read user agreements on websites. And you never double check claims companies make in advertisements. How could you? You lack the necessary expertise and time. You need a third party to cut through the noise and tell you what is going on. Thus, if your aim is the health and well-being of the consumer, and the protection of the ability of the consumer to make good choices, you must have methods of policing information. You need regulation. It is unfortunate but true. You could, again, use the arguments that the free market introduces feedback. But you only compound the issue with that – because feedback only generates more information that needs to be parsed, and requires more work to verify the authenticity of the generators of the feedback.

So there is a trade-off between the free market and regulation. The free market will reduce efficiency, but the efficiency of what? A system where wealth is highly concentrated is an efficient system after all. But is it desirable? You need to design a system such that the free market is directed towards desirable goals. This article details issues with information dissemination in a real world setting.

Another interesting point is conducting unenforceable transactions in a free market, where trust is simply assumed. The case in point is the difference between car insurance in India and America. If there is a collision in America, the process can be a lengthy court battle between the involved parties and insurance companies before resolution is achieved. In India if a collision occurs, the insurance company pays out, no questions asked. The process of resolution is simply not undertaken. Now the question is, which procedure is more efficient in bringing closure to parties – the Indian or American one? Under the assumption that no one wants to crash their cars, thus no one is actually going to get into an accident and claim insurance. Hence every claim is a legitimate accident. Is is simpler to pay out instantly and move on? Or is a litigious process better?

No such thing as a Free Market

One could argue that there is no such thing as a free market because there are always barriers to entry. For example, no one can challenge world wide fast food chains simply because the resources they command are so massive that they control producers, supply chains, prime locations and built in advantages racked up over time. Or take how tech startups often get bought out by large companies. Thus, large companies do not have their dominance challenged, they simply snap up any challengers.

Which, personally, provides a justification for a measure of regulation and oversight, keeping in the mind the concept of trade-offs. The measure should be adequate and justifiable.

The Other Side – Communism

I have focused on the free market here, but what about communism, or the less extreme socialism. What about the left? I haven’t touched upon the left because communism has already been thoroughly discredited and there is little disagreement on it, that I do not feel the need to. Where socialism is concerned, that is what I am angling at here. A balance of the free market and of regulation.

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