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

Chapter Two: Fundamentals of Economic Behavior 45 you can imagine, when prices are changing so rapidly in the official currency, no one used these; in practice trade had ceased using official currency and people simply used dollars. In Germany’s post-WWI environment, no plans could be made; no coordination of economic activity was possible through prices. The only planning that would occur would be for people to try and find a way to avoid being stuck with worthless currency. This would mean hoarding real assets such as gold, housing, food, etc., and no monetary trade would occur. Without trade, the total breakdown of the economy occurs. Institutions also promote coordination between various economic actors by providing information about what other actors will do. Information is scarce and costly to obtain. Institutions are able to reduce the cost of accurate information; you can think of institutions as “congealed” or “embedded” knowledge, since they provide relevant information to aid decision-making. By providing this embedded knowledge, institutions allow more information to be included in our individual plans, which tends to improve the resulting coordination. In market economies, the price system is an institution that most effectively coordinates behavior, and communicates to all how others are reacting and likely to act. For example, if the price of gasoline rises, we can expect people to buy fewer cars that get poor gas mileage. We’ll expand on this concept quite a bit in subsequent chapters. One institution in a market might be bonding agencies, which guarantee a person’s work if he or she damages your house. Let’s say you hire a plumber who is bonded and you have him under contract for a job. If you know he is bonded, you have more information about how he is likely to behave; he’s not as likely to damage your house. He is probably a better overall plumber, or his costs to obtain a bond for his work would price him out of the market. For instance, the contract may require the job completion by a certain date with a significant financial penalty if the plumber doesn’t perform. If he is installing a sprinkler system for your lawn, you can make your plans for the landscaper to begin his work right after the plumber finishes, since you are more certain of his completing the task without any significant problems. Institutions therefore enhance plan coordination. These are just some of the institutions that facilitate growth. There are many others, of course, and we find common characteristics of institutions that enable economic growth. These characteristics include: § § increased information flow between individuals § § incentives to work and produce § § incentives to trade § § anything that reduces uncertainty § § promotion of moral behavior (to understand why, see “Why are Institutions Promoting Moral Behavior Necessary for Free Markets?”)