51. Types of Cooperation

Note: This post is the fifty-first in a series. Click here for the full listing of the series. The first post in the series has more detail on the book 'Systems of Survival' by Jane Jacobs.


The topic of this post is an essay by Joseph Heath on 'The Benefits of Cooperation (pdf)'

Heath posits that there are 5 different ways that people can benefit by working together:
1) Economies of Scale
2) Benefits from trade
3) Risk sharing
4) Self-binding
5) Information sharing

Heath notes that the first theorem of welfare economics demonstrates that competitive markets (which achieve benefits by allowing people to trade with one another) will achieve a perfectly efficient outcome, but that the assumptions behind the theorem rule out all other forms of cooperation:

"The 'invisible hand theorem' (or 'first fundamental theorem of welfare economics'), shows that the competitive equilibrium of a market economy will be Pareto-optimal as long as certain 'standard' conditions obtain. The list is quite long, but includes inter alia constant returns to scale, individuals with well-behaved utility functions, symmetric information, a complete set of futures markets, and in cases of
uncertainty, a complete set of insurance markets.

In other words, the theorem shows that markets achieve perfect efficiency, so long as every other mechanism of cooperative benefit is excluded from consideration – either by assuming that no such benefits are possible, or that all such benefits are freely available. To see how uninformative this is, consider how we would respond
to someone who proposed a model for the 'optimal' production of scientific knowledge, based upon the assumption that both material resources and labor were available in unlimited supply and at zero cost. Whatever its technical merits, such a model would give us very little assistance with real-life policy questions."

Heath goes on to point out how circumstances often force us to choose between pursuing different types of benefits. In the case of economies of scale, there is an obvious conflict between having a large number of firms to make a market more competitive, and having a smaller number of firms so that the bigger firms can achieve greater economies of scale. It's worth nothing that, due to network externalities, any organization that physically extends across geographic territory (i.e. power grid, sewer system, road network) tends to be operated as a monopoly, with the economies of scale overwhelming the gains from competition leading to more trade in this particular case.

The story (conflict between benefits from trade vs. benefits from other forms of cooperation) is similar with risk sharing. Heath gives the example of the enclosure of the commons that occurred in England prior to the industrial revolution. Allowing individuals to take ownership of parts of the commons created far more opportunity for specialization and trade to take place by ensuring that anyone who took the trouble to improve or develop a piece of land could expect to reap most of the benefits from their efforts, rather than sharing them with everyone else in the commons. But the commons system provided a great benefit by insulating individuals from the uncertainties of having their fortunes entirely dependent on one piece of land. Splitting the land into privately owned chunks removed the benefit that arises from reducing uncertainty for individuals by diversifying risks across a large group of people.

By self-binding, Heath means situations where we want to pre-emptively prevent ourselves from taking actions we know we will regret (due to hyperbolic discounting) and enlist others to aid us. The thought reminds me of this passage from Plato's Republic,

"Tell me then, O thou heir of the argument, what did Simonides say, and according to you truly say, about justice?

He said that the repayment of a debt is just, and in saying so he appears to me to be right.

I should be sorry to doubt the word of such a wise and inspired man, but his meaning, though probably clear to you, is the reverse of clear to me. For he certainly does not mean, as we were just now saying, that I ought to return a deposit of arms or of anything else to one who asks for it when he is not in his right senses; and yet a deposit cannot be denied to be a debt.

True.

Then when the person who asks me is not in his right mind I am by no means to make the return?

Certainly not.

When Simonides said that the repayment of a debt was justice, he did not mean to include that case?

Certainly not; for he thinks that a friend ought always to do good to a friend and never evil.

You mean that the return of a deposit of gold which is to the injury of the receiver, if the two parties are friends, is not the repayment of a debt,—that is what you would imagine him to say?

Yes."

On the topic of self-binding, Heath makes the same analogy between borrowing and substance abuse that I did in last week's post,

"Economist David Laibson has argued that financial innovation, by increasing the overall liquidity of assets, has made it increasingly difficult for individuals to create 'golden eggs.' The difference between savings and checking accounts has become purely nominal; the introduction of ATMs has meant that everyone has access to their money at all hours (and so withdrawing a fixed amount at the beginning of the week can no longer be used as a self-control mechanism); reverse mortgages allow people to drain the asset value of their homes; and, of course, consumer credit has rendered the practice of 'saving up' for a major purchase almost obsolete. This sort of 'easy money' is a mixed blessing to consumers, in the same way that a 24-hour beer store is a mixed blessing to the alcoholic."

Again, making it easier to complete trades conflicts with a different form of cooperative benefit.

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What this notion of 5 different forms of cooperative benefits means with regard to the two syndromes identified by Jacobs is not entirely clear to me. The view I'm drifting towards is that the guardian syndrome represents cases where perfect monopoly is required and the commercial syndrome represents something close to the perfect competition ideal.

Cases where economies of scale are all that matters would seem to lead to a monopoly which would fall under the guardian syndrome. Cases where there the benefits to risk sharing far outweigh gains from trade would be similar. Self-binding relies on a hierarchical relationship (the one who is binding themselves submits to the authority of the person who will bind them) such as we find in the guardian syndrome and measures to encourage the generation of new information (intellectual property) often seem to do so by guaranteeing a monopoly to the producer of the information.

Cases where gains from trade need to be balanced against one of these other sources of cooperative benefit would seem to involve a grey area of competition mixed with monopoly in some measure. Perhaps it's not surprising that these areas tend to be an ongoing source of controversy.

4. Network Effects

links to Part 1, Part 2 and Part 3

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The prisoner’s dilemma of the last post was a particular case of negative externalities. This post covers a particular type of positive externalities known as network effects.

Wikipedia, as always, is here to helpfully summarize:

In economics and business, a network effect (also called a network externality) is the effect that one user of a good or service has on the value of that product to other people.

The classic example is the telephone. The more people own telephones, the more valuable the telephone is to each owner. This creates a positive externality because a user may purchase their phone without intending to create value for other users, but does so in any case.

The expression "network effect" is applied most commonly to positive network externalities as in the case of the telephone. Negative network externalities can also occur, where more users make a product less valuable, but are more commonly referred to as "congestion" (as in traffic congestion or network congestion).
Over time, positive network effects can create a bandwagon effect as the network becomes more valuable and more people join, in a positive feedback loop.

So I make a transaction with the phone company that is a win-win for me and the phone company and also for everyone else (a positive externality) who already has a deal with the phone company. The size of my win in the transaction with the phone company depends on how many existing users there are, so after I sign up, the next person to sign up gets an even bigger win, and so on.

In addition to actual networks, standards often have the same structure. If I am using a particular computer file format, every other person who uses that format helps me since I can look at their files without needing to change the format first. The same goes for operating systems, where Windows was able to become the de facto standard for so many years. One of the reasons there is a strong push for open standards in many areas is to avoid having one individual or group extract monopoly rents from all those using the standard in the same manner that Bill Gates became the wealthiest man in the world.

Note that in situations with network effects, there is an initial phase in which relatively small investments / ideas / luck can tip the scales between various people attempting to set up the new standard and then a later phase when one (in some cases two or three) network has emerged victorious and it would take a huge investment of resources or a significant change in the situation in order to remove them from their leadership position.

This is one way to understand the internet gold rush of the 90's. Investors understood that the internet opened up new situations where network effects were strong and that initial investments in money losing companies could pay off later if they were able to win the battle to become the standard. Ebay (the best example of network effects since if you're selling something you want to use the site with the most buyers and vice-versa so every new user benefits all the other users) founder Pierre Omidyar is now a multi-billionaire, much like Bill Gates.