This talk is about two kinds of human cultural exchange systems, the work they do for human betterment, and their relationship with theory and experiment in economics.

1. Personal exchange based on reciprocity and sharing norms in the family, the extended family network and the tribe. This form of exchange emerged early in the human enterprise.

2. Impersonal exchange through market institutions.

Central to both kinds of exchange is what economic theorists have traditionally called “property rights.” A property right, as I use the term, is a guarantee allowing actions to occur within the guidelines defined by the right—such rights need have nothing to do with property in the sense of land or physical assets. We automatically look to the State as the guarantor against reprisal when rights are exercised, but we also know that the State can often be as much a part of the problem of human rights violation as its solution. Property rights, however, predate nation states. This is because social exchange within stateless tribes, and trade between such tribes, predate the agricultural revolution, a mere 10,000 years ago. Both social exchange and trade implicitly recognize mutual consensual rights to act. In what sense are such rights "natural?" The answer, I think, is to be found in the universality, spontaneity, cultural and evolutionary fitness value of reciprocity behavior. Reciprocity in human nature is the foundation of our uniqueness as creatures of social exchange, which we extended to include trade with non-kin and non-tribal members long—perhaps very long—before we adopted herder and farmer life styles.

Political activists juxtapose property rights and ‘human rights’ as mutually exclusive phenomena. But ‘property’ is that over which an individual human, or association of humans, exercise some specified priority of action with respect to other humans. Only humans, but not property, can be recognized as allowed to act without reprisal from others. The anti liberty emotional appeal of the slogan, ‘human rights not property rights,’ stems predominantly from an uninformed egalitarian ethic that seeks to dispossess those who are ‘propertied,’ a precedent that, if accepted universally, can only make us all poorer. Yet the essence of property rights is the right to the product of one’s own labor and to the further productive yield generated by the savings from that product. Property rights mean that (1) if I plant corn I have the right to harvest the yield of that corn, and therefore the right to prevent a passerby from harvesting it; (2) if I save some of the income from the sale of that harvest, and invest in more land, then I have the right to plant and harvest from that additional land. To be ‘propertied’ is to accumulate. To accumulate is to not consume all that my labor, and previous savings-investment, has produced. This allows all my accumulation to remain at work in society at large and for all others to benefit from my capital investment. This is the basis for all wealth accumulation in society. There can be no other basis. If there is any abridgement of my right to so harvest and to accumulate, then there is a direct abridgement of the right of all others to enjoy the benefits of my accumulation, and to a corresponding reduction in their poverty. I love rich people, because they consume such a small percentage of their accumulation, leaving it to work in the economy and make me better off.

One of my dearest heroes, Julian Simon, has written eloquently on The Ultimate Resource: human knowledge, and our relentless capacity to constantly adapt through learning. Prominent in human know-how has been technical knowledge: fire, stone tools, then domesticated animals, agriculture, square riggers, the steam engine, automobiles, aircraft, the computer-communication-www revolution, biotechnology, nanotechnology, and so on without end.

Our most important form of know-how, however, is human knowledge of social exchange systems; this is what made possible our early dominion over nature’s many obstacles, and our great capacity to develop and utilize technology. It is also our least known and appreciated knowledge, because it tends to operate below our conscious everyday experience. It was through personal exchange that we leveraged and multiplied individual productivity in small groups, enabling our ancestors to occupy all the major islands and every continent except Antarctica by the year 1000 AD. Eventually, exchange through markets vastly multiplied individual productivity by linking groups of hundreds of millions of people across dozens of borders.

Personal Exchange
Personal exchange provided incentives for each individual to contribute to the whole, while also serving them-selves; the hunter, lucky in the hunt on one occasion, shared his kill with those who returned with nothing to show for their effort; but this social obligation also gave the fortunate hunter the right to receive meat from others, when they were successful and he was not. Sharing meant giving so that one could also receive, and this pre-historical principle has been badly distorted by present day do-gooders who seek to redistribute wealth.

Less visibly, personal exchange also greatly leveraged group productivity through task subdivision and specialization. Thus, in stateless hunter/gather societies, the women and children gathered fruits, nuts, tubers, and grains; men hunted; and old men advised in the hunt, continued to fashion tools and weapons and helped in gathering. In Arctic environments, where there was little to gather except twigs, brush or dried mammoth chips for fires, the women prepared the skins, cut hide strips for sewing, fashioned warm clothes, snared rabbits, made and set salmon traps; the men made weapons, skin boats, called umiaks, hunted and harvested the great animals of land and sea. This specialization increased individual productivity, and through their exchange-sharing norms, every individual benefited from the greater wealth created by it.

I want to illustrate personal exchange with two quotations.

The first quotation is from Peter Freuchen’s Book of the Eskimos, 1960, pp 53-54 on the “first harpoon” principle. Freuchen managed the first Danish trading post at Thule in Artic Greenland some 100 years ago. He came to know and love the Inuit people, married an Inuit, and raised two children by her.

“A (polar) bear is so constructed that it does not like to have spears in it," say the Eskimos. As if to prove what they say, the bear—as they run right up to the beast with their incredible courage and hurl their puny weapons at it—takes the spears that have lodged deeply in its flesh and breaks them as if they were matchsticks.

When the bear finally is felled, the dogs calm down with a strange suddenness. They lie down on the ice and watch without excitement as their fallen enemy is being skinned. According to custom, all the hunters present are to get parts in the quarry, in this case both of the meat and skin.

There are three pairs of trousers in a bearskin. If there are more than three hunters present, the ones who threw their spears last will usually be generous enough to leave their parts of the skin to the others. The hunter who fixed his spear first in the bear gets the upper part. That is the finest part, for it includes the forelegs with the long mane hairs that are so much desired to border women's kamiks (boots) with.

…So the hunter measures with his whip handle from the neck down, and marks the length of his own thighs on the skin and cuts off at that mark. The next hunter does likewise with the next piece, and the third one gets the rest.

Note that the Inuit “first harpoon” principle is an incentive rule that rewards with a greater value, the greater risk and cost of being the first to harpoon this incredibly dangerous prey. It is an equal opportunity rule, not an equal outcome rule that evolved from ancient prehistory. Any member of the hunting team is free to go first, pay the risk cost, and collect the higher revenue. All others, whose contributions cannot be differentiated, share equally in the revenue that is left. That deep human ethic surfaces in laboratory experiments routinely showing that when there is no way to differentiate individual contributions to the whole, then people support the equal outcome rule. But when individual contributions to the group can be differentiated, then they prefer a rule that rewards in proportion to individual contributions—more to those who sacrifice more for the group.

But Freuchen continues, and gives us some insight into cultural change, adaptation and rule modification in the light of a great increase in potential revenue over that which prevailed in the environment under which the first harpoon rule traditionally emerged.

Since the white men like to have a whole bearskin with head and claws on it, a rule was made in the Thule district that if a hunter who had a "first harpoon" needed the skin to sell in the shop, he had only to say: "I skin with claws." Then he had to give his mates parts in the meat only, not in the skin. Often it is the intention of a young man to get himself income easily and quickly, just by saying these four little words.

But they are difficult to pronounce. For they show that he isn't able to catch foxes enough to trade with. In addition, they make his friends trouserless. Often a remark is heard about "the good sense in keeping the skin whole!" and "This is a nice skin. Here is a man who uses his good luck when it comes along!"

Such sarcasms do not fail to hit home. But then the young man breaks out in a laughter: "Naw, now I must laugh. At last, there is something amusing to tell others! Game mates think that the bear was to be skinned with snout and claws so as to rob them of the much desired trouser skins. Of course, it was a joke--the skin belongs to everybody!"

With that, he feels relieved and can—since he…(had first harpoon)—go up to the next two in line and measure the length of their thighs with his whip handles to transfer it to the bear skin. There is much satisfaction in this gesture.

As I interpret it, we see in Fruechen’s description a modification of the “first harpoon” norm in which the person now has the right to propose that he “skin with claws,” but the proposal’s acceptance requires consent from game mates, perhaps unanimity, but we are not told. Consent allows flexibility: for example a particularly reputable “first harpooner,” might have his proposal accepted immediately, while an upstart’s proposal might be rejected until his reputation is established.

The second quotation is from Adam Smith’s first book, The Theory of Moral Sentiments, 1759, p 225:

Of all the persons...whom nature points out for our peculiar beneficence, there are none to whom it seems more properly directed than to those whose beneficence we have ourselves already experienced. Nature,...which formed men for their mutual kindness, so necessary for their happiness, renders every man the peculiar object of kindness, to the persons to whom he himself has been kind.

Notice that Smith is talking about reciprocity, but without using this word from our time. Close friends and associates everywhere constantly trade favors, and they do it with hardly a self aware thought; they do it naturally, without deliberate calculation, and keeping score. But Smith then goes on to talk about reputation formation, and negative and positive cultural responses, again without using those words.

…Though their gratitude should not always correspond to his beneficence, yet the sense of his merit, the sympathetic gratitude …, will always correspond to it. The general indignation of other people, against the baseness of their ingratitude, will even, sometimes, increase the general sense of his merit. No benevolent man ever lost altogether the fruits of his benevolence. If he does not always gather them from the persons from whom he ought to have gathered them, he seldom fails to gather them, and with a tenfold increase, from other people. Kindness is the parent of kindness.

The important point I want to emphasize is that all contemporary cultures continue to carry the reciprocity practices that enabled our ancestors to cooperate and occupy the continents and larger islands, even with limited technology. Although today it is markets that serve specialization and enable gains from exchange, our social lives still very much reflect the reciprocity norms of traditional small in-groups.

Impersonal Exchange
Let me now turn to impersonal exchange among strangers, which in function and substance is also reciprocity and sharing, but it occurs through institutions of markets and prices using money as an intermediary of reciprocal giving for what is received instead of social norms of sharing across time. Trade and markets somehow evolved out of the much more ancient forms of personal exchange. Markets provide incentives for widely dispersed individuals with different information, skills, languages, customs and cultures to seek betterment for self, and in the process, cooperate and contribute to the whole through trade.

Impersonal exchange leveraged the creation of wealth, through specialization across large populations, vastly exceeding that which could ever be imagined in the small bands and tribes that originally peopled the earth.

As noted in Adam Smith’s second great book, The Wealth of Nations, 1776, pp 19-20:
It is not from the benevolence of the butcher, the brewer or the baker that we obtain our dinner, but from their regard for their own interest…This division of labor…is not originally the effect of any human wisdom, which foresees and intends that general opulence to which it gives occasion. It is the necessary, though very slow and gradual, consequence of a certain propensity in human nature, which has in view no such extensive utility: the propensity to truck, barter and exchange one thing for another.

In spite of the vulgarization of Smith in both the popular and some very loose academic literature, this is not a statement about greed and taking; it can only be understood as a statement about giving so that you can receive in return; it’s about exchange, and the division of labor that was the unintended consequence of exchange.

Functionally, there is no difference between reciprocal giving and sharing in personal exchange, bartering corn for hogs in a rural market, or serving others by teaching their children to read and write, and using the monetary income so earned to buy the groceries and clothing produced by others. Specialization and trade through markets is an engine of wealth creation, which wealth is widely shared through the prices that result.

But there is a world of difference in people’s perceptions of the two forms of exchange. Everybody, except the sociopath, understands the former and can see that good comes from intending good in personal exchange. The overwhelming majority of people, however, do not understand markets, and the good that flows to others by working, performing and producing for yourself and family.

We know that the essence of markets is that individual cost and value information is private and dispersed, and that command and control economies inevitable must fail to deliver the goods because the appropriate information is not, and cannot be, given to any one mind. What laboratory experiments bring to the table is a methodology, using cash motivated subjects, for actually demonstrating to skeptics the power of markets to aggregate such dispersed private information to produce efficient equilibrium outcomes. Market principles become a real live operating reality, much more than a black board exercise, that so many students do not find compelling. Moreover, most economists who engage in these teaching exercises do not carry the principles into their political economy. I hope to make a dent in that professional mind set, but I am by no means foolishly optimistic.

Equally important, however, is the test bedding function of the laboratory in evaluating the incentive properties of new market systems, applied to commodities and rights that have traditionally been government owned or regulated, such as electric power and airport landing rights; also there are entirely new tradable rights like emission permits. In these cases to rest with the ideological position, “let the market do it,” is to invite failure and a setback in the cause of liberty. In structuring new markets, with unique new features, the devil is in the details of technology, contract design, and incorporating the constraints of physics, meteorology and complex network interdependence into the dynamics of the trading process.

I particularly want to emphasize what I think is the most important theme in Hayek, and in the Scottish philosophers: neither of the two kinds of exchange traditionally have been deliberate Cartesian constructs; they represent emergent self-ordering systems; invented by nobody, yet everybody; they come in an infinity of flavors that evolved to fit particular circumstances; they very in form across different cultures, but functionally serve the same purposes.

New arrangements, even if initially constructivist, as in the recent new markets mentioned above and in test bedding exercises, must have survival properties that incorporate opportunity costs and physical challenges invisible to constructivist modeling.

These considerations lead to an alternative, ecological concept, of rationality: an emergent order based on trial-and-error cultural and biological evolutionary processes. It has led to home- and socially-grown rules of action, traditions and moral principles that underlie property rights in impersonal exchange, and social cohesion in personal exchange. To study ecological rationality we use rational reconstruction—for example, reciprocity or other regarding preferences—to examine individual behavior, emergent order in human culture and institutions, and their persistence, diversity and development over time. Experiments enable us to test propositions derived from these rational reconstructions.

In closing, I want to reemphasize that in people’s personal exchange relationships, their experience is that good comes from intending to do good. This is why, I believe, that over and over again peoples everywhere have supported programs to intervene, regulate, redirect and control markets. They believe that intervention, driven by good intentions, can improve markets, but the result, over and over again, is untended consequences with the opposite effect. People’s folk perceptions of markets are like their folk perceptions of the earth. We experience it as flat, not round. How many centuries did it take for people to incorporate into their operating beliefs and understanding, that the earth is in fact round.

But markets in no way need destroy the foundation upon which they probably emerged—social exchange between family, friends and associates. Thus, individuals can be habitual social exchangers and vigorous market traders as well. Consequently, there is the ever-present flat-earth danger that the rules of ‘personal exchange’ will be applied inappropriately to govern or modify the extended order of markets. Equally dangerous, the rules of impersonal market exchange may be applied inappropriately to our cohesive social networks.

I close with one of my favorite quotations from Hayek:

…we must constantly adjust our lives, our thoughts and our emotions, in order to live simultaneously within different kinds of orders according to different rules. If we were to apply the unmodified, uncurbed rules of the…small band or troop, or…our families…to the (extended order of cooperation through markets), as our instincts and sentimental yearnings often make us wish to do, we would destroy it. Yet if we were to always apply the (competitive) rules of the extended order to our more intimate groupings, we would crush them. (Hayek, 1988, p 18).

Vernon L. Smith is the recipient of the 2002 Nobel Prize in Economics, and sits as the Rasmuson Chair in Economics at the University of Alaska Anchorage for the academic year 2003-2004.

Dr. Smith also is Chairman, Interdisciplinary Foundation for Research in Experimental Economics, and Professor of Economics and Law, George Mason University.