Broken Symmetry

Do Good Fences Make Good Neighbors?

Why, yes, they do.

There's a debate among academics in patent law now over whether patents create an anticommons (or "gridlock") problem. The debate tends to assume without proving that there would not be a worse commons problem were patent rights peeled back to disable the system of exclusive rights to technology that developed in the 19th century in the United States.

But patent rights weren't the only property rights that were secured for the first time in the 19th century United States. In fact, the invention of barbed wire (itself patented) contributed to a dramatic decrease in the costs of securing real property in the 19th century. And to what effect? Richard Hornbeck reports:

This paper uses the introduction of barbed wire fencing to the American Plains in the late 19th century to estimate the effects of property rights on farmers' production decisions. Farmers were both formally and informally required to build fences to secure their land. From 1880 to 1900, the introduction and universal adoption of barbed wire reduced the cost of fencing, relative to wooden fences, most in counties with the least woodland. Over that period, counties with the least woodland experienced substantial relative increases in the improvement intensity of farmland, the value of farmland, and the productivity and production share of crops most in need of protection. This substantial increase in agricultural development appears to reject increased security of property rights due to barbed wire fencing. Some states' previous efforts to reduce the need for fencing are not found to have had similar effects, however, suggesting a difficulty protecting property rights in sparsely settled areas through legislation and the court system.

Why would state-enforced rules not work as well? See Robert C. Ellickson and Coase. (Still not transparent? See Calabresi and Melamed.) And note that patents are more like barbed wire than like state legislative efforts to shift the costs of fencing to herd owners (described in the paper).

If this seems like ancient history to you, then consider the fact that our government is going to have to learn how to be 100x more efficient with its tax revenues over the next few decades if we are to avoid insolvency.

Here's another interesting point: Ellickson found that even barbed wire was too expensive to be worthwhile in close-knit communities of ranchers and farmers like Shasta County, California.

What is the Systems Theory of Economics?

Systems theory is an attempt to put Hayek, Coase, Williamson, North, and Ellickson on more quantitatively rigorous foundations. Systems theory is an umbrella term for physics models of networks and dynamical systems that are used to understand how interconnected flows can end up in stable or unstable local equilibria, spontaneously synchronize, and generally evolve over time in feedback loops.

Here are some of the basic hypotheses about human behavior that might be associated with systems theory:

• Individuals have preferences for goods that can be measured in units of flow (quantity consumed/produced per unit time).
• Individuals seek to optimize the fit between their flow preferences and available flow using available information about past and present available flow.

These together suggest that individuals can be modeled as a nexus of flows of cash and other goods. In turn, the interconnected streams of these flows lead to additional hypotheses about the behavior of the integrated system of flows.

• Feedback loops in flow among individuals can result in more spatially and temporally stable preferences by synchronization of flow.
• A nexus of synchronized flows may be a firm or a market depending on the structure of interconnections. (I.e., the ability to synchronize flow over time determines what structures will persist.)
• Firms that synchronize with higher-bandwidth can operate at lower cost, sell at higher margin, or both.
• Firms with scale-free architecture are the most cost-efficient, but also the most susceptible to catastrophic failure.
• (Perhaps most surprisingly) Under certain circumstances, individual preferences will spontaneously synchronize through market price signals.

There is an evolutionary mechanism at work here in that the nexus of flows that constitutes a firm is in competition with other nexuses of flows for additional flow. Over time, some network structures will survive better. And the success or failure of a particular network will, of course, have an impact on how the preferences of individuals within it will evolve over time. There are deep connections between systems theory and the evolutionary theory of psychologists like Mihaly Csikszentmihalyi and sociologists like Donald T. Campbell. But the kind of data and scale of the models used by systems theory is more traditionally associated with economics.

Much of systems theory has been anticipated by New Institutional Economics, and in some cases sociology and psychology. The work from Haidt and Ehrenreich on hive psychology and collective joy, for example, is consistent within broad contours of the physics models of self-organized synchronization. Robert H. Frank's work on positional goods can be understood in terms of the sustainability of certain integrated flow structures over long times. In general, Thomas Schelling seems to have had these sorts of models in mind in his writing, although he tended to focus on the potentially destructive outcomes after long periods of repeated interactions.

I'm going to try to turn each of these bullet points into a separate post over the next few weeks or months.

Letter Comment to the FTC on the Evolving IP Marketplace

Here are a few excerpts:

According to systems theory, innovation emerges from iterated cycles in which data, theory, and the people who collect data and form theory constitute feedback loops, which evolve over time. Each cycle manifests as the gathering and exchange of information among a network of experts who act as gatekeepers to a set of symbolic rules and procedures. Following the terminology of Mihaly Csikszentmihalyi, I call the network of experts a “field,” and the set of symbolic rules and procedures a “domain.” To give examples, topology, physical chemistry, and constitutional law are domains. Each of these domains is associated, respectively, with the fields of mathematicians who specialize in topology; academic and practicing physical chemists; and academics, practicing lawyers, and judges who work on constitutional law.

From the point of view of an economist, the most important difference between systems theory and neoclassical theory may be that systems theory permits for economic actors (the field) to have preference functions (the domain) that evolve over time. As a result, although neoclassical theory is still a useful model of economic activity when changes in preferences are small within the window of time in which economic activity is observed, more generally no stable equilibrium may be reached because preferences may change during the period of observation. In addition, because systems theory need not assume that economic actors know how their preferences have or will change over time, an assumption that actors will try to match their allocation of resources to their preferences can be called “rational” only in a weak sense. Under systems theory, whether an economic actor will engage in an activity of consumption, production, or exchange is a function of: (1) their history of preferences; (2) their history of consumption, production, and exchanges with others; and (3) the frequency of their exchanges with others. Whereas within neoclassical theory institutions are designed to promote allocative efficiency, within systems theory institutions are designed to promote the discovery of information about preferences, and thereby the synchronization and frequency-matching of consumption and production activities through exchange and cooperation.

For example, the systems theory makes explicit the spatial and temporal dynamics underlying the knowledge problem described by F.A. Hayek in “The Use of Knowledge in Society.” With the systems theory in mind, we can identify the function of markets with their facilitation of the exchange of information and coordination of economic activity independent of central planning. This is in stark contrast with neoclassical theory, which often identifies the function of markets with the maximization of aggregate utility based on an assumption of stable preferences — a function that cannot be carried out by a central planner beyond a small scale. The systems theory therefore identifies markets as a mechanism for rewarding information exchange and cooperation, thereby facilitating economic growth.

Download Letter Comment to FTC on the Evolving IP Marketplace (Final)

Revisiting Robert Ellickson's Critique of Functionalism

An excerpt from Order Without Law:

[E]arly functionalists had a tendencey to consider a human group as a single organizm whose "health" could be examined. It was then easy for them to surmise that Darwinian evolutionary processes would help favor the survival of socially adaptive norms. In the following passage the libertarian scholar Friedrich Hayek lapsed into this sort of analysis:

It is not only in his knowledge, but also in his aims and values, that man is the creature of civilization: in the last resort, it is the relevance of these individual wishes to the perpetuation of the group or the species that will determine whether they will persist or change. It is, of course, a mistake to believe that we can draw conclusions about what our values ought to be simply because we realized that they are a product of evolution. But we cannot reasonably doubt that these values are created and altered by the same evolutionary forces that have produced our intelligence. All that we can know is that the ultimate decision about what is good or bad will be made not by individual human wisdom, but by the decline of the groups that have adhered to the "wrong" beliefs. [The Constitution of Liberty at 36]

(Before nonlibertarian scholars dismiss these thoughts, they should be aware that both Lon Fuller and Thomas Schelling have also harbored suspiciously functionalist sentiments.) [Citing Fuller's "Human Interaction and the Law," and Schelling's Micromotives and Macrobehavior at 124-133].

The difficulty with this sort of organic analysis is that evolutionary processes, as most biologists understand them, select either genes or individual organisms, not groups, for survival. [Citing Dawkins's Selfish Gene and E.O. Wilson's Sociobiology at 106-129; and noting V.C. Wynne-Edwards's dissent.] Assume, for example, that honesty is a functional norm in the sense that, if all the members of a group were consistently honest, they would each be better off than if everyone were consistently dishonest. Would the Darwinian struggle favor the survival of the groups of honest persons? Not necessarily. A dishonest individual living in an environment surrounded by honest people might especially prosper, surrounded by easy marks. As a result, the Darwinian process would tend to select dishonest people for survival. In short, to support a Panglossian scenario of group evolutionary progress, functionalists could not rely simply on the biological theory of natural selection. Instead, they had to develop theories to explain how social-control systems would evolve within groups to prevent successful invasions by deviants who would subvert group welfare.

The punchline is that group selection theory is now enjoying a resurgence among some evolutionary biologists, notably including E.O. Wilson, whom Ellickson cites in support of the proposition that the theory has been rejected by evolutionary biologists. Wilson and Holldobler recently published, The Superorganism, which lays out a group selection theory for how cooperation evolved among insects.

The other objections to functionalism raised by Ellickson are also moot now in view of the improved theoretical tools for being more quantitative about functionalism. In particular, associating a group with a network, and individuals with nodes therein, permits evolution of group behavior to be modeled using mathematical models for network growth and decay. Such models help to eliminate much of the conceptual circularity to which Ellickson objects in this passage.