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

Chapter Ten: It’s all About the Institutions! 239 However, another student asked you how your paper came out and you tell him that you think you really have a good chance at an “A” since you put so much work into it. At this point, he pulls out a gun (in the presence of the teacher!) and asks you to give him your paper. You comply, and he calmly erases your name and writes his own name on top, and then hands it to the teacher. The teacher smiles at him and says “good work.” You now see what it might be like to live in a world with no property rights. What is your reaction going to be in the future? You will either (1) try to conceal all your papers, (2) get a bigger gun (not a good response), or (3) not do any work at all. All three of these options are much poorer choices than simply being rewarded for your work, but they may very well be the best you can do. There are parallels in the market process. If you really work hard to produce a good or service for others, and the state either allows theft or takes your wealth via redistribution schemes, you are likely to try and (1) hide evidence of your wealth, (2) spend large amounts of resources to protect your wealth (hire lobbyists or private security depending on whether the threat is public or private), or (3) not produce anything. Societies that do not protect private property tend to have significantly lower levels of output (see the Index of Economic Freedom and compare economic results of those who protect property rights with those that do not). The implication is that changes to institutions such as property rights can have profound economic impacts; and unfortunately they are usually not part of any public discussion in support of a given policy. Likewise, most any history of economic or financial development will highlight the advent of double entry bookkeeping (which supports proper accounting of assets and liabilities) as perhaps the most important development to facilitate modern capitalism. Accounting standards can either be a formal or informal institution depending on the country and culture you live in, but most modern countries have formal accounting standards which support free markets by providing more transparency for investment decisions. We saw major economic problems in the U.S. when fraudulent accounting led to the Enron’s bankruptcy (among other firms that engaged in criminal misconduct). Once again, countries that don’t have good accounting standards or permit fraud in those standards tend to have lower levels of economic performance. For another example of formal institutions, consider that our constitution guarantees us against unreasonable search and seizures. The fourth amendment states: The right of the people to be secure in their persons, houses, papers, and effects, against unreasonable searches and seizures, shall not be violated, and no Warrants shall issue, but upon probable cause, supported by Oath or affirmation, and particularly describing the place to be searched, and the persons or things to be seized. Because of this protection, we can be more secure in our business activities, including commerce over road. We don’t have to pay a bribe to each official that stops us on the