The Vital Role of Norms and Rules in Maintaining Open Public and Private Economies

Abstract

This paper argues that trust-enhancing institutions are needed to support economic activity, and shows that these institutions become more complex to deal with information asymmetry among economic actors. Using Crawford and Ostrom's (2005) institutional grammar, it tracks the development of trust-enhancing institutions from a theorized "state of nature" where actors can only rely on shared strategies, to the development of norms to stabilize expectations, and finally to the rise of the rule-based institutions such as the Law Merchant as a means to handle more complex informational asymmetry. The paper concludes with recommendations for sound institutional design, suggesting that improper design can "crowd out" people's natural sense of trust and result in failure to achieve desired outcomes.