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__________________________________________________________________
Mauricio
Zachrisson
Girón
Informal
Institutions
,
Stars
and
Increasing
Returns
We
are
just
an
advanced
breed
of
monkeys
on
a
minor
planet
of
a
very
average
star
.
But
we
can
understand
the
Universe
.
That
makes
us
something
very
special
.
I
.
Introduction
.
—
Stephen
Hawking
A
shared
characteristic
among
economists
is
the
need
to
make
assumptions
about
the
world
in
order
to
simplify
their
models
and
be
able
to
draw
certain
conclusions
from
them
.
It
is
a
tradeoff
economists
must
make
between
realism
and
simplicity
,
and
most
of
the
time
they
are
led
to
the
latter
.
One
of
the
sacrifices
that
have
been
made
out
of
necessity
is
the
institutional
environment
where
individuals
transact
and
make
decisions
.
The
purpose
of
this
paper
is
to
understand
how
this
institutional
environment
—
which
most
economists
take
as
given
—
actually
functions
.
As
will
be
shown
,
institutions
have
a
certain
characteristic
that
makes
them
more
dynamical
than
has
been
noted
,
namely
,
that
institutions
have
increasing
returns
.
Individuals
live
in
a
world
that
has
rules
and
conventions
that
influence
their
decisions
,
and
sometimes
these
various
“
rules
of
the
game
”
compete
with
each
other
.
This
paper
will
not
follow
the
typical
economic
methodology
of
optimization
and
static
equilibrium
analysis
,
but
it
will
instead
use
a
simpler
and
more
intuitive
style
,
an
analogy
.
This
tool
will
allow
us
to
use
a
comparative
analysis
to
highlight
and
understand
how
increasing
returns
affects
the
dynamics
of
institutions
.
Using
an
analogy
has
its
setbacks
,
and
one
in
particular
is
when
the
analogy
is
taken
too
far
.
The
literary
figure
is
used
only
as
means
of
explanation
and
to
facilitate
understanding
,
and
at
no
point
should
it
be
interpreted
that
stars
and
individuals
act
alike
.
The
structure
of
the
paper
is
as
follows
.
Section
II
will
explain
what
institutions
are
,
and
how
contemporary
economists
have
dealt
with
them
.
Section
III
will
introduce
a
specific
kind
of
increasing
return
that
has
been
found
in
technology
research
:
network
externalities
.
Section
IV
will
apply
the
concepts
in
section
III
to
informal
institutions
,
followed
by
a
simple
model
for
understanding
its
effects
in
section
V
.
The
astronomical
analogy
will
be
used
in
section
VI
to
see
some
examples
of
the
model
in
the
previous
section
,
followed
by
the
concluding
remarks
in
section
VII
.
Mauricio
Zachrisson
Girón
is
a
student
at
Universidad
Francisco
Marroquín
,
Guatemala
.
He
is
majoring
in
economics
.
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__________________________________________________________________
II
.
Institutions
,
Formal
and
Informal
.
“
Institutions
matter
”
is
a
phrase
that
has
been
recently
expressed
by
many
economists
,
and
it
is
the
reason
why
so
much
research
has
been
done
lately
in
this
field
.
The
study
of
institutions
has
existed
for
centuries
,
but
only
recently
has
it
been
incorporated
into
the
field
of
economics
(
the
New
Institutional
Economics
,
NIE
).
But
what
are
institutions
?
This
is
a
question
those
same
economists
have
been
asking
themselves
.
There
are
several
definitions
,
though
this
paper
will
follow
the
lines
of
two
economists
in
the
semantics
of
institutions
:
Douglass
North
and
Samuel
Bowles
.
According
to
North
,
“
Institutions
are
the
humanly
devised
constraints
that
structure
political
,
economic
and
social
interaction
.
They
consist
of
both
informal
constraints
(
sanctions
,
taboos
,
customs
,
traditions
,
and
codes
of
conduct
),
and
formal
rules
(
constitutions
,
laws
,
property
rights
).”
1
Bowles
says
,
“
Institutions
are
the
laws
,
informal
rules
,
and
conventions
that
form
a
durable
structure
to
social
interactions
among
the
members
of
a
population
…
Institutions
influence
who
meets
whom
,
to
do
what
tasks
,
with
what
possible
courses
of
action
,
and
with
what
consequences
of
actions
jointly
taken
.”
2
Although
both
definitions
differ
in
some
aspects
,
they
give
an
insight
into
what
constitutes
an
institution
.
These
social
mechanisms
inform
,
assign
and
coordinate
individuals
in
repeated
social
interactions
.
“
Institutions
”
is
a
broad
term
,
so
it
is
of
great
importance
to
dis-
tinguish
what
kind
of
institutions
exist
in
order
to
understand
their
independent
effect
on
individuals
.
Oliver
Williamson
has
done
a
good
job
in
identifying
them
.
He
separates
them
in
four
levels
,
which
correspond
to
a
different
area
of
study
.
The
figure
on
the
following
page
(
from
Williamson
,
2000
)
illustrates
the
different
levels
,
the
frequency
(
the
amount
of
years
needed
for
radical
change
of
institutions
),
and
the
purpose
of
the
institution
.
3
Most
economic
studies
are
focused
in
the
L4
institutions
,
and
have
recently
moved
to
L3
and
L2
.
Studies
of
L1
institutions
have
been
relatively
few
,
but
there
has
been
interesting
research
in
this
area
,
which
will
be
mentioned
throughout
the
paper
.
Williamson
said
,
“
An
identification
and
explication
of
the
mechanisms
through
which
informal
institutions
arise
and
are
maintained
would
especially
help
to
understand
the
slow
change
in
Level
1
institutions
.”
4
That
is
the
purpose
of
this
paper
,
to
understand
the
functioning
of
informal
institutions
.
With
the
help
of
current
research
in
technology
,
and
an
analogy
with
the
formations
of
stars
,
I
attempt
to
give
an
insight
on
how
Level
1
institutions
are
formed
,
on
how
they
grow
,
and
how
they
may
disappear
.
An
example
of
informal
institutions
is
crucial
for
the
understanding
of
the
ideas
presented
in
this
paper
.
Long
distance
trading
was
a
complex
business
in
the
past
.
During
Roman
times
for
example
,
when
merchants
imported
grains
,
they
faced
a
big
problem
,
uncer
–
1
Douglass
C
.
North
,
“
Institutions
,”
Journal
of
Economic
Perspectives
,
5
(
Winter
1991
),
p
.
97
.
2
Samuel
Bowles
,
Microeconomics
:
Behavior
,
Institutions
and
Evolution
(
Princeton
University
Press
,
2006
),
pp
.
47-48
.
3
Oliver
E
.
Williamson
,
“
The
New
Institutional
Economics
:
Taking
Stock
,
Looking
Ahead
,”
Journal
of
Economic
Literature
,
38
(
Sept
2000
),
p
.
597
.
4
Ibid
.
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__________________________________________________________________
tainty
.
They
had
to
purchase
grains
from
far
lands
,
from
people
who
they
did
not
know
and
never
would
,
wait
for
a
boat
that
carried
their
goods
,
with
no
information
of
their
whereabouts
,
and
hope
that
the
amount
and
quality
of
the
grains
were
what
they
expected
.
These
problems
are
still
faced
today
,
but
in
a
lesser
degree
due
to
technology
advances
such
as
the
Internet
and
satellites
,
but
to
the
Roman
merchant
these
were
problems
big
enough
to
stop
importing
.
Merchants
tried
to
face
these
problems
through
various
means
,
including
trading
with
family
only
.
But
the
demand
for
grains
grew
to
the
point
where
they
needed
to
deal
with
strangers
.
An
informal
institution
was
developed
,
the
endorsement
of
a
merchant
by
a
knight
or
senator
.
If
a
senator
were
satisfied
with
the
results
from
the
merchant
,
he
would
endorse
him
and
even
recommend
him
to
other
businessmen
.
For
this
to
work
,
the
merchant
had
to
be
sure
that
other
senators
would
accept
another
senator
’
s
endorsement
,
and
that
other
merchants
would
be
competing
for
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a
senator
’
s
endorsement
.
The
bigger
the
network
of
senators
and
merchants
that
accepted
the
endorsement
mechanism
,
the
greater
assurance
the
marginal
merchant
would
have
over
the
acceptance
of
his
endorsement
.
The
more
people
were
part
of
the
institution
,
the
more
attractive
it
would
be
to
an
outsider
,
and
when
an
additional
outsider
joined
the
network
,
the
attractiveness
of
the
institution
would
grow
even
more
.
This
means
that
informal
institutions
have
increasing
returns
,
something
that
has
been
pointed
out
by
many
economists
,
including
North
and
Bowles
.
But
why
do
they
have
increasing
returns
?
What
made
the
senatorendorsement
mechanism
in
Rome
have
increasing
marginal
returns
when
an
additional
merchant
got
involved
in
the
institution
?
To
answer
these
questions
,
I
turn
to
a
helpful
tool
in
understanding
increasing
returns
in
technology
.
III
.
Technology
and
Network
Externalities
.
Robert
Metcalfe
,
the
creator
of
the
Ethernet
,
was
the
person
who
first
established
the
term
“
network
externality
.”
Metcalfe
believed
that
the
value
of
a
network
depends
on
the
number
of
users
in
it
.
The
more
people
used
a
certain
network
,
the
more
possible
connections
existed
between
individuals
,
which
increases
its
value
.
For
example
,
if
only
three
people
used
the
telephone
for
communication
,
there
would
only
be
six
possible
connections
,
but
if
there
were
four
people
using
the
telephone
,
there
would
be
twelve
possible
connections
.
Therefore
the
value
of
the
telephone
network
is
proportional
to
the
number
of
nodes
made
possible
by
the
number
of
phone
users
.
Let
M
be
the
value
of
a
network
in
a
Metcalfean
way
,
we
then
have
:
(
1
)
(
)
Mi
≡
f
ni
f(
ni)=
ni
(
ni
−1
)
where
ni
is
the
number
of
the
users
in
the
network
i
,
and
is
therefore
restricted
to
positive
values
.
As
we
can
see
,
f
(
ni
)
is
positively
correlated
with
ni
,
which
means
than
the
value
of
the
network
is
increasing
with
the
amount
of
users
.
Now
consider
the
sensitivity
of
the
value
of
the
network
i
(
Mi
)
to
a
change
in
the
amount
of
its
users
.
Taking
the
first
and
second
order
derivatives
we
get
:
(
1
.
1
)
dM
i
dn
i
d
2
Mi
2
dni
=
2n
i
−1
=
2
The
first
order
derivative
is
always
positive
.
The
second
order
derivative
is
always
positive
at
any
given
ni
,
which
means
f
(
ni
)
is
a
convex
function
.
We
can
now
see
there
is
a
marginal
increasing
network
value
with
an
increase
in
the
number
of
its
users
.
This
is
the
main
point
in
Metcalfe
’
s
idea
of
the
value
of
a
network
;
not
only
is
the
value
of
a
network
a
direct
and
positively
correlated
function
of
the
number
of
users
,
but
it
is
marginally
increasing
.
This
is
what
is
called
the
Metcalfe
Law
.
Consider
now
how
network
externalities
,
explained
by
the
Metcalfe
Law
,
work
in
an
institution
,
for
example
the
institution
of
money
,
and
in
this
case
gold
.
This
institution
provides
a
means
of
exchange
between
numerous
individuals
.
The
value
of
gold
as
a
means
of
exchange
depends
on
the
number
of
people
who
use
gold
for
this
purpose
.
If
there
are
only
ten
people
using
gold
,
there
would
be
90
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