More on Contracts

February 5, 2010

In my last post, I quoted Coase saying, “[T]he economic system obviously operate[s] in a way different from the way it would if it was all based on contract, which was of course one’s first assumption. But it’s wrong”

Robert writes:

“Who is contending otherwise, by the way?

Which, the more I think about it, the more strenuously I want to object. Lots and lots of people contend otherwise. Remember that post two days ago about Planet Money that you (quite reasonably) didn’t read? Well, one of the main points of that was to respond to the lawyer, quoted on the program, who said, “Walking away from your mortgage is an economic decision.” That’s just not true, and this lawyer was a serious person, who does this stuff for a living, contending otherwise.

Those mortgages were sold with the expectation that they would be repaid, an expectation that went beyond the terms of the contract. But the quintessential relationship upon which that contract was based, between an individual borrower and a bank, had already been removed from its context via mortgage-backed securities. It has been further damaged by the public perception that banks were receiving massive bailouts with taxpayer money.

Pace Robert, lots of people don’t pay attention to economic relationships that aren’t explicitly set out in contracts. This is the knowledge problem that Hayek made the subject of his 1974 Nobel Prize lecture. But in modern macroeconomics, people don’t talk about the knowledge problem; they talk about models, representative agents, rational expectations, and aggregate demand. Macroeconomics is data-driven, and you can’t drive with data if most of the data you need isn’t written down or explicitly stated anywhere.

I’ve filled enough space that I can now post a Calvin and Hobbes. Enjoy.

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7 Responses to “More on Contracts”

  1. Thomas Says:

    I don’t know about Marx or “earlier incarnations” of myself, but I will say that your pal Doug North would agree with you that “capitalism depends on personal relationships.” In North’s rubric, “informal institutions” form the bedrock for laws and other explicitly stated or “formal” institutions. In this case, the norm of mutual respect between parties underlies the formal institution of the legal contract. As you suggest, informal institutions tend to be qualitative, hard to codify into rigid data points, yet all the more important because of this.

    Makes sense to me. Like Robert, I don’t see anything surprising here.


    • “Capitalism defined

      ‘…capitalism is basically a system where everything is for sale, and the more money you have, the more you can get.’
      -Noam Chomsky ”

      -T. Phillips, Personal Correspondence, 2007

      “If you want a more practical orientation for this definition of profit, I’ll define profit as the goal of capitalism. Noam Chomsky defines capitalism as ‘a system where everything is for sale, and the more money you have, the more you can get.’ The silly simplicity of this quip belies the enormity of its implication: capitalism requires and engenders growth.”

      -T. Phillips, “(clarification)”, 2008

      Look fellas, this is the hard thing about arguing economics. I agree that all the assumptions I’m using are obvious. That’s why I’m so confident about them. What I’m not sure I’m communicating successfully is how important are the implications of these obvious assumptions. It’s easy to say that business depends on more than hard-headed profit-making. It’s harder to see why that matters.


  2. Also, not to call you both liars, but I just find it implausible that on considering the kinds of relationships businesses have with their suppliers or suppliers with their customers, you both thought it was too obvious to even mention that the vast majority of actual, written contracts don’t come anywhere close to specifying all the terms of the relationship.

  3. Thomas Says:

    I mentioned North, in response to your baiting, to demonstrate that even crazies like me don’t believe that business takes place in a valueless context. I doubt even Chomsky believes that.

    I can certainly agree that you’re not communicating successfully. “The vast majority of actual, written contracts don’t come anywhere close to specifying all the terms of the relationship.” — that’s a clear, interesting, far from obvious notion. If that’s what you’re claiming, then you should incorporate it into the body of your post.


  4. Alright, fine, how about “earlier incarnations of me”? I found the Coase quote surprising. I had always believed that there was a sharp distinction between the economic sphere and the morals/traditions/etc. of a society. That’s one of the hidden assumptions of liberals like me (and you). That we can basically look at and comprehend situations and interactions, and even offer helpful advice on how to improve them.

    The Coase quote is evidence for conservatism. You can’t just sweep away old institutions because you don’t really know how they work, and you don’t really know how people would behave in their absence.

  5. Rrrobert! Says:

    I don’t think the lawyer is saying capitalism doesn’t operate on a moral as well as a contractual level. Instead, I think he’s urging his clients to reevaluate their assumptions about the moral requirements of capitalism.

    I don’t think there’s any doubt that the mortgage is issued on the assumption that most borrowers will repay their debts if they can; as you point out, that assumption is built into the interest rate.

    I think there are two claims that bear on the lawyer’s position. The first is one about the limits of moral obligations under capitalism – that, though capitalism still relies on agreements, it also makes provision for rational economic actors – i.e., it relies on people to do what they say as long as it’s basically reconcilable with their self-interest. The thrust of this argument is that having an underwater mortgage is akin to bankruptcy, and that the system provides moral escape from such a situation without too much judgment.

    The second claim is more interesting, I think. The wheels of capitalism are greased by moral relationships outside of capitalism – respect for other people, not harming them, etcetera. And though those relationships do save everybody money, they don’t have force within capitalism itself. So if you take away the relationship, you take away the moral imperative. I.e., if you’re local banker, to whom you owe a moral responsibility, is no longer an actual person but an intangible company, why should you feel an obligation to have the same kind of relationship with your bank?

    Alternately, you could say that modern capitalism has violated its side of the moral responsibilities – that the relationships between banks and people is no longer one of mutual agreement and respect, but one of exploitation and trickery, and that you’re under no obligation to keep your word to such a counterparty.

    I don’t know how I feel about these, but they’re not insubstantial arguments. Also, if you happen to be predisposed to Marxism, you can see how this would fit in with a broader narrative in your head about capitalism inevitably destroying the relationships on which it relies, and thus dooming itself, though I think that would be taking it too far.

    It’s interesting, though, to think that by redefining our moral obligations to mega-corporations, we might end up returning competitive advantage to local businesses that were previously buried by economies of scale.


  6. […] I agree with everything that Robert wrote here. It was what I was trying to say. Oh, but one caveat: I agree that Marxists see capitalism as […]


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