Adam Smith showed us the importance of free markets for the welfare of the people in a nation (Smith, 1776). At that time people were restricted to a local environment and governments thought they could best protect national interest by preventing too much exchange. The market has undoubtedly liberated many people from local bonds by promoting free choice. This liberation has stimulated innovation and increased welfare. Thus, the highly specialized institution of a market—specialized as it concerns the exchange of commodities only—was very successful. This success is explained by the fact that in the 18th and 19th centuries markets made it possible for people to establish more comprehensive relations to other cultures and resources. This feature surpasses the commodity dimension usually represented in a market. Commodities from the Indies, China or Egypt, and its accompanying technical innovations connected people with other cultures and stimulated their imagination. In this paper we seek to develop a theory that is founded on these institutional dimensions.

Economists elaborating on the theory of markets emanating from Smith’s seminal work, have taught us that “free” means “perfect competition”, which is arrived at if no individual has any observable influence on the formation of the market price. That means a person enters a market anonymously, and only her anonymous willingness-to-pay is recognized and communicated. Economists have also shown that the perfectly competitive market mechanism is amoral: it processes what is demanded or supplied, without any moral filtering, and it accepts any initial distribution of wealth, however unjust. As argued above, this seems far removed from the underlying basic relational realities.

Furthermore, modern market institutions are designed in a way that goes well beyond the description of 18th century commodity markets. Markets are established for much more complex entities as services in the health care sector and complex securities in capital markets. There is a need for another benchmark to assess the performance of such markets. To answer that question we introduce a relational economy and derive primeval institutional properties of this relational economy. Thus, we approach the economy as a complex network of relational activities generating economic values. These foundations allow us to explore rather directly economic services as well as commodity trade as sources for the generation of such economic values. As such this approach seems an urgently needed complement to the standard neo-classical approach in exploring these issues of complexity in service economies.

In particular, we aim to extend the Lancasterian approach—separating a commodity from its properties and explaining the value of a commodity from the utility of its properties (Lancaster, 1966)—to the performance of economic institutions. We propose to separate these trade institutions from the basic relational framework in which these institutions are embedded and supported. Thus, a trading post explicitly emerges within a structure of inter-personal trade relations, developing into a formal market based on the price mechanism. Therefore, a trading post is viewed as a cooperative activity among related participants. We introduce a relational framework in which such cooperative activities can emerge and characterize stability properties of emerging cooperation structures. Our claim is that all specialized institutional frameworks have to meet these stability properties when performing smoothly.

Within the relational framework of value-generating activities, we focus on the stability of these activity patterns. We use standard equilibrium concepts from matching theory (Roth and Sotomayor, 1990) to describe such stable patterns. We then identify conditions on the relational structure of value generating activities that guarantee and characterize the existence of such stable activity patterns. The identified conditions point unquestionably to institutional features. This allows us to additionally interpret economic institutions as social rules that support and guarantee generic stability in an economy. Instability of such patterns, on the other hand, causes eventual undermining of the institutional superstructure of the economy.

In particular we consider a generic form of stability in our framework as a state of the fundamental structure of economic relationships such that for every possible configuration of individuals’ productiive abilities and preferences, the economy possesses at least one equilibrium state. Within such a generically stable structure, value-generating relations are essentially transformed into anonymous exchange relations and the generation of economic values can be optimized .

In Gilles, Lazarova, and Ruys (2007) we introduced an economy in which economic agents could either be autarkic or engage in a value-generating relationship with one other agent. This resulted into a relational matching economy. Within this framework, we introduced a stable matching pattern as a set of activated relational activities such that no agent has the incentive or opportunity to change the relational activity that she participates in. In particular, we investigated generic stability, the property that the economy possesses at least one stable activity pattern for any distribution of economic values. The main insight emerging from this analysis is that generically stable matching patterns emerge if and only if economic agents assume complementary social roles that support the formation of their value generating relationships. Following our discussion above, such socioeconomic roles form an institutional foundation that supports and promotes stable economic development.

We extend this approach to include more broadly defined cooperative economic activities. In our relational setting we assume that such cooperative activities require a convener, who brings together a group of economic agents to form such a value-generating cooperative economic activity. Thus, the convener facilitates or initiates the cooperative activity. In this regard these cooperative activities are relational forms of clubs as introduced seminally by Buchanan (1965). Our main assumption is that the convener can only invite economic agents to participate in a cooperative activity if they have a binary matching relationship with the convener. In other words, the convener can only form cooperative activities with acquaintances with whom she interacts.

Furthermore, the economic values generated through these cooperative activities are expressed as hedonic utilities. This is a standard technique from the theory of clubs as well. Werefer to the review of Scotchmer (2002) for a discussion of this technique. It allows us to reduce the analysis of the formation of relational cooperative activities to a single dimension, expressed through the hedonic utility functions of the various economic agents.

We thus arrive at a relational economy in which economic agents can engage into three types of economic activities: autarkic activities, binary matching activities, and cooperative activities formed by a convener. Each of these three types of activities generate different hedonic utility levels for its participants. We explicitly assume that there are no widespread externalities among the various activated activities; the generated values are solely the outcome of the activities themselves. (This does not, however, exclude various forms of externalities among the members of a cooperative.)

Again, we device a standard equilibrium concept in which each agent participates in exactly one permissible economic activity. In equilibrium, no agent has an incentive to join another potentially accessible activity. Such an equilibrium is called a stable activity pattern. We distinguish two types of stability. Regular stability expresses a pattern of “open” cooperatives in which conveners cannot deny other agents access to the cooperative. Remarkably many trade institutions such as markets, trading posts and communal commons satisfy this openness condition. In an open cooperative, the convener is simply a coordinator. Strong stability expresses a pattern of “closed” cooperatives in which conveners have the ability to dismiss any of its members. Examples of such closed cooperatives are production teams in the sense of Marshak (1955). In these closed cooperatives, conveners act more like managers than coordinators.

We discuss the conditions under which such (strongly) stable activity patterns exist. The first existence result concerns economies in which there are no explicit externalities among the members of a multi-agent cooperative economic activity. Since these members can be separated, these activities are called separable cooperatives and exhibit rather standard properties. Examples of such separable cooperatives are trading posts and services such as religious sermons, collective insurance provision, and the standard concept of a commons. In all of these cases the participants of a cooperative activity do not affect each other directly through interpersonal externalities. If a relational economy only has separable cooperatives, we can show that there exists a strongly stable activity pattern for every hedonic utility profile if and only if the underlying relational structure exhibits a partial acyclicity property. In particular, relational economies with an acyclic relational structure and separable cooperatives only are generically stable.

Second, we investigate relational economies in which cooperatives are potentially nonseparable in the sense that these cooperative activities might generate interpersonal externalities. Non-separable cooperative activities are prevalent in our contemporary service economies and include open-source software development and information services (e.g., Wikipedia), health care provision, and higher education. In general, the complexity of interpersonal externalities prevents us to identify conditions under which stable activity patterns can emerge. However, for size-based externalities, we can show that acyclicity of the underlying relational activity structure is sufficient to guarantee such generic stability. Standard examples of cooperatives exhibiting size-based externalities such as congestion and crowding are most highly used (semi-) public facilities such as beaches and parks on sunny summer days.Under these conditions, strong stability is, however, infeasible.

For these size-based externalities, our analysis shows that acyclicity of the structure of permissible matching activities is sufficient to establish generic stability. Again, this acyclicity condition can be interpreted as referring to a specific institutional setting of the economy. In particular, acyclicity is a feature in economies with hierarchical leadership structures. As a consequence, hierarchical leadership organizations can be viewed as integral in the establishment of stable economic development, a feature that has not yet been pointed out in the literature.

Other non-separable cooperatives might be subject to more complex externalities among its members. Such examples are health care providers and universities. These conveners bring together a team of highly trained professionals, in this case health care professionals and faculty, respectively, and a group of clients, in this case patients and students, respectively. In particular the team of professionals determines the quality and nature of the services provided through the cooperative. In these cases of more complex externalities, the existence of stable activity patterns can no longer be guaranteed.

The paper is organized as follows. Section 2 introduces our relational approach to pairwise economic cooperation. Section 3 extends this model to include multi-agent cooperative economic activities. Section 4 analyses the emergence of stable interaction patterns if there are no externalities and Section 5 discusses the implications of the introduction of certain externalities.

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