Game Theory and Anarchy

David Friedman asks the question: If both parties are unable to verbally communicate with each other what determines how they interact with each other? For example, suppose two people are supposed to meet somewhere in NYC, but they haven’t discussed where. Thomas Schelling says that people typically end up meeting at noon at Grand Central Station. The people pick a time and place that everyone knows and is obvious. This allows coordination without communication.

David Friedman’s main point is to try to understand why property rights are respected. Friedman says that property rights are determined (and respected) based on people’s strategic behavior. Friedman says that people’s behavior is based on Schelling points, which are finding solutions to the problem of coordination without communication, either because communication is not possible or the people involved have no reason to believe the other people. For example, suppose a dollar can be divided between 2 people, on the condition that both sides agree on how the dollar will be divided. Such a scenario creates a holdout problem (or bilateral monopoly) where each person has an incentive to want a larger share of the dollar. It is unlikely that a person will only accept 10 cents and allow the other person to keep 90 cents, and it’s unlikely that a person wanting 90 cents of the dollar will believe the other person will agree to this. The likely result is that the dollar will be split in half since each person has an incentive to agree with how the dollar will be divided (in order to get it) and to maximize the amount he gets; a fifty-fifty split is the most likely scenario to make both parties as well off as possible.

Friedman talks about how peaceful resolution is more likely to occur when people agree. For example, peaceful resolutions about property rights are more likely to occur among people who have the same theory of property rights. Friedman’s main point is that strategic behavior determines how property rights are respected or not and that using strategic behavior when it comes to interacting with each other is what makes civil society possible and not the existence of top-down legal systems. For example, what makes peaceful coexistence possible is the use of strategic behavior to try to understand people’s behavior. A person is unlikely to give into a person’s threats because if he does this shows that threats work and is more likely to be bullied again in the future. Likewise a person is more likely to follow through on exchanges (or threats) that were agreed to after one party follows through and the other does not, partially because he wants a reputation of being able to deliver on his promises.

An example Friedman gives is a person willing to chop down a tree that is blocking someone else’s orchard in exchange for an apple. Why is it that a person wouldn’t just steal the apple, but if the after the agreement is reached the person who chopped down the tree would use force to get the apple if the apple owner failed to abide by his end of the deal? The reason is because people typically act based on other people’s expectations. A person who just stole apples would be considered a thief and unjustified in taking that which doesn’t belong to him. He would not only cause friction between him and the apple grower, but also any of the apple grower’s friends or others who view theft as wrong. On the other hand, a person wants a reputation as not being a push-over and since there are more people who consider it justified to take that which was promised you after you have fulfilled your end of the bargain, a person is more likely to conform to such expectations. A person who took the apple by force only after not getting reimbursed can say that he held up his end of the deal and he is not stealing the apple since it is now rightly his. He is able to find more people sympathetic to his situation now, which makes it more likely why the lumberjack would only take the apple by force after the apple orchard failed to act out his part of the deal. As Friedman mentions, while the lumberjack was just as capable of stealing the apple in either scenario, he has more of a reason to carry it out when the apple grower cheated him and the apple grower has less of a reason to resist. Such actions create a focal point that influences people’s behavior in the future. The reason I will keep up my share of the bargain is to not only develop a reputation for honesty, but because I will get more backlash for failing to do so and have less people defend me when I commit fraud and don’t keep my promises.

Friedman mentions that if someone gets extorted for money, “It is in my long-run interest not to back down because if I do I can expect further demands: ‘if once you have paid him the danegeld/ You never get rid of the Dane.’” (Friedman 1994, 8). If the roving bandit and the people in the village are around equally as strong, the people in the village are less apt to give to the bullying since that tells the roving bandit that his bullying is successful and so has a greater incentive to extort more in the future.

David Friedman’s main point is that the rules which are just and efficient are also the rules and laws enforced by the government which he lives under. In other words, the rules that are enforced exist because they are both just and efficient. According to justice, each person owns himself. Having each person a right to his body is not only just but is the most efficient. It is easier for me to control the use of my body than someone else. Likewise, according to Friedman, “our actual civil order is the result of extended bargaining, based ultimately on natural property. It was my control over my body that made the initial steps out of the state of nature possible. So natural property is relevant to what is—to the existing pattern of laws and norms.” (Friedman 1994, 12). 

Friedman says that in a world without transaction costs, any initial allocation of property rights is efficient, but in the real world with transaction costs, the most efficient allocation of property is where I own me and you own you since it is easier to enforce such rules than a society where I own other people or everyone owns a portion of everyone else.

In short, Friedman is claiming that rules tend to move in the direction that is at least locally efficient and that the rules that are most efficient (where people own themselves and what they homestead) and just are also the rules which tend to exist in society. So rather than having a tension between what should be and what is, justice, efficiency, and the legal rules which exists complement each other.

The above explains how property rights, norms, customs, and laws emerge. The most successful laws are laws based on previous focal points. Customs and norms are not static or arbitrary but based on continuous interaction with people. The most successful interactions and behaviors are the ones that cause the norms to stick and get codified in law, as in the case of the common law. The common law was based on a case-by-case basis where whenever a conflict arose, the most efficient way to settle a dispute was the one which was written down for how to solve the dispute in the future. Through a process of trial and error, the norms that won out were those that were the most efficient at settling disputes by conforming to people’s expectations.

According to legal scholar Hasnas, the common law was not legislative law, but case-by-case law. The law was about finding a result that both opposing parties found acceptable in order to resolve a dispute without violence having to be a solution (Hasnas 2008, 114).

When the basis of law is contractual law, where the goal is mutual benefit and reciprocity, the rules that emerge are rules conforming to people’s norms and expectations with each other. As shown above these occur as a result of repeated interactions with others, not based on government edits. The law was not created by government and can exist in its absence.

Suppose that instead of a nation-state, the market provided law. It is likely to be the case that the law would be as Friedman predicts and has shown in the case of Medieval Iceland. The laws would be laws against murder, theft, and violence. People would contract out to a defense agency of their choice. If a dispute arose between a person contracted with Defense Agency A and Defense Agency B, it is unlikely that the court would be run by either agency but would find an impartial agency neither party contracted with in order to get an impartial verdict. Both parties would agree to abide by the verdict and if one party did not, it is likely that he would be declared an outlaw, like during Medieval Iceland, and during the Law of the Marches, and during the Law Merchant (and during the 1,000 years of anarchy in Ireland).

From the 8th century (possibly before) until the 17th century, Ireland was in a state of anarchy since there was no legislature, no bailiffs or police, and “no trace of State administered Justice” (Peden 1977, 83). Instead, in Ireland there was contractual law where people hired people representatives to enforce contracts for them and joined in sureties for protection (Peden 19777, 86-87).

If the United States decided to go anarchy by having the state eliminating its taxing power and allowing competition, it is reasonable to assume that such private defense agencies would protect property and to a greater degree than the government does. One major difference between the state and the market is that firms in the market are concerned with making a profit and successful firms would engage in behavior that would generate a profit. Would firms make more money by stealing and robbing from people and acting like a stationary bandit, or would they make a higher profit by protecting people and their property?

The libertarian theory of property rights is homesteading, which is first come, first serve. The first person to be in contact with the property is the one who gets to claim ownership over it. The idea of homesteading is not an arbitrary theory of property, but a natural one. Related to homesteading is the endowment effect. The endowment effect is that people value the good they possess more highly than a good they do not possess. The endowment effect creates a feeling of loss aversion where people are willing to spend more resources devoted to protecting their property than others would to seize theirs. Loss aversion is when a person is more sensitive to losses than gains (Gintis 2006, 2). 

Thaler explains an experiment showing the endowment effect in action. In the experiment, people were randomly assigned the role of seller, buyer, or chooser. The sellers were given a mug (that originally sold for $6 at the school store) and were asked whether they would be willing to sell the mug at prices ranging from $0.25 to $9.25. Choosers were asked to choose for each price between receiving the mug or that amount of money. The experiment revealed that the average buyer was willing to buy the mug for $2.87 and the average seller was willing to sell the mug for $7.12. Choosers acted similarly to buyers by being on average indifferent to getting the mug or receiving $3.12. What the experiment revealed is that the owners of the mug valued the mug at more than twice the amount as nonowners (Gintis 2006, 4). The experiment shows that once a person is currently in possession of a product he is willing to spend more money to keep it than someone who is not currently in possession of the product.

The endowment effect is not just an economic theory done in experiments, but a natural tendency among humans and animals. In one study, observers looked at a group of 11 toddlers and 13 preschoolers to see how often a toddler or preschooler possessed an object and how often they took the object from others. The results found that success was strongly and equally related to both how strong the person was and prior possession. The observers also found that toddlers recognize possession as a basis for asserting control rights, but do not respect the same rights in others. The preschoolers, more than twice the age of the toddlers, use physical proximity both to justify their own claims and to respect the claims of others (Gintis 2006, 7). The endowment effect demonstrates that even very young children are willing to spend more energy defending what they own then they are taking others.

Stevens studied horses competing for water. The water was located in pools that would result after severe rains. What Stevens reported was that out of the 233 horses observed, 178 (80%) of the horses who were by the pool first were able to successfully ward off the horses that tried to take their spot away from them (Gintis 2006, 8). A similar experiment showed butterflies successful warding off intruders who were in their space. Thus, even animals recognize the homesteading theory of property.

Using our knowledge of the endowment effect it would not be unreasonable to conclude that people would be willing to spend more money to defend their property and their life than spend resources to steal and hurt other people. Since market defense agencies are in the business of making a profit, it seems likely that they would make a higher profit defending people’s property and life than being hired as goons to steal from others. People are willing to spend more money to defend their rights than they are to violate others. Therefore the market would tend to reward the most profit-maximizing firms, which would be those who defended persons and property.

Similar to Friedman’s example with the apple grower and the lumberjack, a focal point is more likely to occur that reflects people’s expectations with each other. Even in primitive societies, the taking of an object currently in possession of another individual was rare (Gintis 2006, 8). Since most cultures and norms already have laws against theft, defense agencies that were able to fulfill people’s expectations of punishing theft would be met with a good reputation, whereas agencies that looted from people would be viewed with condemnation, just like how the mafia is viewed today. Successful businesses depend on good reputations, and being fair promotes a better reputation than an agency that is going to rob and extort people.

During the Anglo-Saxon era, people were part of a surety system where they were responsible for the other members. There is no reason to believe that such a similar system would not come again. Under a polycentric legal system people joined voluntary associations that would come to their aid. 

In a market, there would likely be insurance agencies where people would contract out and pay for crime insurance, the same way people pay for life and health insurance. Insurance agencies suffer from an adverse selection problem. People willing to spend the most on health insurance are likely to be people who are already sick or going to be shortly, which is why insurance companies have measures to reward people for being healthy and give lower rates to people who voluntarily take precautions. So too, people wanting to spend the most amount of money on crime insurance tells the insurance company such people are those most likely to commit crimes since why would a person unlikely to commit crimes want to spend a lot on crime insurance? Therefore in order to prevent this adverse selection problem, crime insurance companies would give lower rates for those who prove they are peaceful, have a good reputation, and signal to the insurance company that they aren’t going to be committing a lot of crimes.

References:

Friedman, David. "A positive account of property rights." Social Philosophy and Policy 11.02 (1994): 1-16.

Gintis, Herbert. "The evolution of private property." Journal of Economic Behavior & Organization 64.1 (2007): 1-16.

Hasnas, John. "The obviousness of Anarchy." Anarchism/Minarchism: Is a Government Part of a Free Country (2008): 111-132.

Peden, Joseph R. "Property rights in Celtic Irish law." Journal of Libertarian Studies 1.2 (1977): 81-95.

[Except from my article, "Anarchy: The Lesser of Two Evils," which can be found here: https://works.bepress.com/daniel_rothschild/10/]