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November 24, 2003
Social Capital as Credit
Social capital, or aggregate (connected) reputation, is a form of credit. Some formal transactions can be supported by social capital. Informal transactions are rarely underpinned by financial credit or legal agreement and instead rely entirely social capital. We all have our internal calculators keeping tacit track of who is wronging and righting, the health of the relationships and adjusting our actuarial tables according to experience.
Sometimes a service arises to make a portion of this explicit, such as Ebay's or Slashdot's reputation system. Scaled reputation systems to date are, in fact, subjective proxies a set of localized decisions that result in a visible emergent pattern the pattern itself being open to interpretation. But if there is enough social agreement to play the rating game, they decrease transaction risk and increase liquidity. Not just for those with better ratings, but for the network or market as a whole.
Say you are selling a couch to a neighbor at a garage sale who is going to pay for it when its delivered next weekend. The transaction could be supported by formal credit using means as varied as an IOU or contract (providing legal recourse as credit) or financial means such as a deposit, escrow or credit card. It could also be supported by social capital. The key difference is an implied agreement that default means a negative impact on the defaulting party, not from explicit penalties, but to reputation with the seller and others in the neighborhood that is a network. The overhead cost for securing a transaction with financial credit is greater.
Using social capital to underpin transactions is an iterative approach. It only works if there will be future transactions and each occurs within the context of a social network. Game theory holds the best strategy is to trust but verify with each iteration. This presents greater risk up front, but builds trust and reputation with each iteration, so over time transaction risks and costs decrease. But it should be clear that without additional legal recourse for default it only works for smaller transactions.
In absence of formal credit, social capital is the norm. Micro-markets, more traditional cultures and third world countries practically run on social capital as a result. Up until the advent of the Internet, markets and networks that run on social capital were unable to scale. The sad irony is that the markets that need scaled reputation the most still lack access to supportive technologies.
The only cap to abundant potential connections is our mental capacity to manage relationships (150 active ones at a time). New tools are giving us greater capabilities to recall and invoke latent ties, but this is a hard barrier. Whats interesting is how with the cost of group forming falling, local networks are becoming denser, membership more dynamic and new clusters of localized decisions are ripe for enabling emergent patterns.
The potential supply of social capital is abundant, only held back by search and transaction costs. Social software and social networking are rapidly driving these costs towards zero. The pace of capital formation is accelerating because of two additional factors.
In the parlance of network or systems thinking: in the absence of connections, nodes become state attractors. In other words, when the amount of connections is limited, the value of connections is high.
Economists have an applicable rule for this as well: Says Law
, or supply creates its own demand. Now Says Law doesnt work when there is money involved (creates an arbitrage opportunity, otherwise supply-side economics would make sense), but it does apply to barter, reputation and micro-markets. When money is involved, it provides a universal arbitrage path, causing a fight over equilibrium and discounting the impact of Says Law at a macro scale.
This is one reason why you cant trade goods or cash for social capital. Or if you do, it disrupts equilibrium across markets. Now I am sure some elaborate schemes have allowed traders on eBay to assume others identities and some virtual world economies have crossed this boundary. But the point is you cant monetize social capital in aggregate, because it operates at a micro-scale. You can foster social capital for the value of its emergent patterns and what it enables: the flow and production of other tangible and intangible assets. The value of social capital is local, but its impact is global.
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