No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Ten: It’s all About the Institutions! 238 paper every specific aspect that we expected in a purchase, commerce would grind to a halt. Most business relationships are with long-term suppliers and customers, and most of those relationships are governed informally through cultural norms of what “should” be done or what is “fair.” Today’s entrepreneurs don’t define those norms; they take advantage of the existing culture that embedded best practices into behaviors. The handshake is one way to commit each market participant’s commitment to their word, as well as an implicit agreement to follow unspoken cultural norms of how the transaction should take place. In his Nobel Prize lecture, economist Douglas North describes institutions this way: “Institutions are the humanly devised constraints that structure human interaction. They are made up of formal constraints (rules, laws, constitutions), informal constraints (norms of behavior, conventions, and self-imposed codes of conduct).” We often think of formal institutions (especially things like the U.S. Constitution) as very difficult to change, but informal constraints can often be more difficult, or at least take more time. We can pass a civil rights law in 1964, but how long does it take for people to really see all people as children of the most high God? Nevertheless, we are guided by both our culture and our laws. Many of these things help guide us through the murky waters of time and ignorance that are present in the market process. Formal institutions tend to operate through law, whereas informal institutions tend to operate through social customs. FORMAL INSTITUTIONS Institutions are not merely a consideration in economics, they are the very foundation of how we relate to one another and make choices. In the U.S. where we have a relatively “free” economy with market exchange and private property rights, we often take for granted the benefits that the institution of private property rights yields to society. Private property rights (or from a Christian perspective, private stewardship responsibilities) are a formal institution in that we have laws to define what constitutes property and what protections our property has. This institution is absolutely foundational for an economy to function. Imagine a world where you went to school and were assigned a term paper that constituted the only score for the class. Let’s say you worked really hard, learned a lot, and on the final day of class you bring your term paper in to receive your grade. Institutions are not merely a consideration in economics, they are the very foundation of how we relate to one another and make choices. “Institutions are the humanly devised constraints that structure human interaction. They are made up of formal constraints (rules, laws, constitutions), informal constraints (norms of behavior, conventions, and self-imposed codes of conduct).” – Douglas North, Nobel Laureate