Contents

1. Introduction: Firms as market-free zones
2. The wheels of change: Valve’s ultimate symbol of an alternative ‘spontaneous order’
3. What are corporations for?
4. Spontaneous order via time allocation and team formation: Valve’s way
5. Conclusion: What Valve signals for the future

1. Introduction: Firms as market-free zones

Every social order, including that of ants and bees, must allocate its scarce resources between different productive activities and processes, as well as establish patterns of distribution among individuals and groups of output collectively produced.

While all societies featured markets (even primitive ones), market-societies emerged only very recently (around three centuries ago). The difference between a society-with-markets from a market-society is that in market-societies the factors of production are commodities (e.g. land, labour and tools) and, therefore, their employment is regulated through some market mechanism (e.g. the labour market). In this sense, market societies (which emerged during the past three centuries) have the distinctive feature that the allocation of resources, as well as the distribution of the produce, is based on a decentralised mechanism functioning by means of price signals: the activities, goods and services, and processes whose associated price rises attract more ‘attention’, and are invested with more resources (e.g. land and labour), while those whose prices decline repel producers.[1]

Market-societies, or capitalism, emerged when, some time in the 18^th century, the expulsion of peasants from their ancestral lands (the so-called Enclosures in Britain), and their replacement with sheep (whose wool had become an internationally traded commodity), gave rise to the gradual commodification of land (with each acre acquiring a value reflecting the value of wool that could ‘grow’ on it) and, then, of labour (as the, now, landless peasants were eager to sell their labour time for a loaf of bread, money, anything of exchange value). Once land and labour became commodities that were traded in open markets, markets began to spread their influence in every direction. Thus, societies-with-markets begat market-societies.

Interestingly, however, there is one last bastion of economic activity that proved remarkably resistant to the triumph of the market: firms, companies and, later, corporations. Think about it: market-societies, or capitalism, are synonymous with firms, companies, corporations. And yet, quite paradoxically, firms can be thought of as market-free zones. Within their realm, firms (like societies) allocate scarce resources (between different productive activities and processes). Nevertheless they do so by means of some non-price, more often than not hierarchical, mechanism!

The firm, in this view, operates outside the market; as an island within the market archipelago. Effectively, firms can be seen as oases of planning and command within the vast expanse of the market. In another sense, they are the last remaining vestiges of pre-capitalist organisation within… capitalism. In this context, the management structure that typifies Valve represents an interesting departure from this reality. As I shall be arguing below, Valve is trying to become a vestige of post-capitalist organisation within… capitalism. Is this a bridge too far? Perhaps. But the enterprise has already produced important insights that transcend the limits of the video game market.

2. The wheels of change: Valve’s ultimate symbol of an alternative ‘spontaneous order’

If I were asked my opinion of what Valve’s symbol should be, I would recommend a depiction of a wheel, like those which every desk at Valve comes equipped with so as to enable us to move about the company at will, to join whichever working group we want, to form new ones spontaneously and without seeking anyone’s permission. The said wheel, at least in my eyes, symbolises Valve’s attempt to create, within the company, a successful ‘spontaneous order’ based not on price signals but, rather, on decentralised, individuated, time allocations.

Many enlightened corporations do a song and dance about their readiness to let employees allocate 10% or even 20% of their working time on projects of their choosing. Valve differs in that it insists that its employees allocate 100% of their time on projects of their choosing. 100% is a radical number! It means that Valve operates without a system of command. In other words, it seeks to achieve order not via fiat, command or hierarchy but, instead, spontaneously.

The idea of spontaneous order comes from the Scottish Enlightenment, and in particular David Hume who, famously, argued against Thomas Hobbes’ assumption that, without some Leviathan ruling over us (keeping us “all in awe”), we would end up in a hideous State of Nature in which life would be “nasty, brutish and short”. Hume’s counter-argument was that, in the absence of a system of centralised command, conventions emerge that minimise conflict and organise social activities (including production) in a manner that is most conducive to the Good Life. Steadily, these conventions acquire a moral dimension (i.e. there is a transition from the belief that others will follow the established conventions to the belief that others ought to follow them), they become more evolutionarily stable and, in the end, function as the glue that allows society to be ordered and efficient albeit without any centralised, formal, hierarchy. In short, spontaneous order emerges in the absence of authoritarian hierarchies.

Hume’s views influenced one young man in particular: Adam Smith, the economists’ patron saint. Indeed, Smith’s ‘invisible hand’ is no more than an application, and extension, of Hume’s spontaneous order to market-societies. Smith’s argument, in case we have forgotten, is that markets are an example of spontaneous order, where price movements (in reaction to market forces) coordinate individual efforts in a manner that, as if by the help of some invisible hand operating behind our backs, promotes the public good (much better than any ruler who strives to promote it).

While the concept of a ‘spontaneous order’ harks back to Hume and Smith, it was Friedrich von Hayek, the doyen of modern day libertarians, who coined the term. Taking his cue from Adam Smith, Hayek used the ‘spontenous order’ idea as a stick with which to beat into submission all ideas in favour of economic planning (socialist planning in particular) and all arguments in favour of an activist state.

Hayek’s argument was predicated upon the premise that knowledge is always ‘local’ and all attempts to aggregate it are bound to fail. The world, in his eyes, is too complex for its essence to be distilled in some central node; e.g. the state. If we hardly understand our own preferences and capabilities, how on earth can we hope to aggregate the knowledge of what people want and what societies can produce within some central agency; however well meaning that agency might be? All attempts to centralise this infinite, and unknowable, quantity of knowledge will, inevitably, end up in serfdom.

The miracle of the market, according to Hayek, was that it managed to signal to each what activity is best for herself and for society as a whole without first aggregating all the disparate and local pieces of knowledge that lived in the minds and subconscious of each consumer, each designer, each producer. How does this signalling happen? Hayek’s answer (borrowed from Smith) was devastatingly simple: through the movement of prices. E.g. whenever the price of balloons goes up, this signals to balloon makers that ‘society’ wants more balloons. Thus they produce more, without any agency or ministry telling them to do so; without any need to concentrate in some building or server all information about people’s balloon preferences, or about the technology of producing balloons. As for Hayek’s intense dislike of the state, trades unions, municipalities, indeed any collective agency, the reason is that he believed that (a) such bodies interfere with the price signals (e.g. through ‘distorting’ taxes) that are society’s only chance to coordinate its activities well and efficiently; and (b) aggregating profoundly local knowledge was the first step toward collectivising decision making for the benefit of the decision makers and at great cost to everyone else. 

Be that as it may, there is a twofold problem with Smith’s and Hayek’s ‘spontaneous order’: First, it restricts too heavily the scope of Hume’s original notion of an order that evolves spontaneously. Hume thought that humans are prone to all sorts of incommensurable passions (e.g. the passion for a video game, the passion for chocolate, the passion for social justice) the pursuit of which leads to many different types of conventions that, eventually, make up our jointly produced spontaneous order. In contrast, Smith and Hayek concentrate their analysis on a single passion: the passion for profit-making. Moreover, Hume also believed in a variety of signals, as opposed to Hayek’s exclusive reliance on price signalling. Secondly, Hayek’s argument that markets protect us from serfdom (i.e. from authoritarian hierarchies) is weakened substantially by the fact that he has precious little to say about corporate serfdom; about the hierarchies that millions must submit to (when working for Wal-Mart or Microsoft for instance) in order to make a living or to get a chance to unfold their talents.[2]

In a section below I argue that Valve’s wheel is pertinent because it symbolises an attempt to create another form of spontaneous order (closer in spirit to Hume than to Hayek) within a corporation. One which, instead of price signals, is based on the signals Valve employees emit to one another by selecting how to allocate their labour time, a decision that is bound up with where to wheel their tables to (i.e. whom to work with and on what). But before we get there, let us take a closer look at what corporations are for, at least according to four important thinkers.

3. What are corporations for?

Before we try to shed analytical light on Valve’s internal workings and management structure, let us recount what four key political economists had to say about the role and function of firms. This is how they answer the basic question: What are firms for?

Adam Smith

Smith begins his Wealth of Nations (1776) with an account of how a pin-making firm manages to produce so many pins, i.e. efficiently, via the utilisation of a clever division of labour. Clearly, for Smith, firms are the locus of the division of labour. Firms are good for the purpose of creating economies of scale and thus of making it possible to reduce costs inexorably while boosting output geometrically. However, firms sees a threat to the Good Society because an inordinate success of one firm poses a threat to competition, the solvent of market (or monopoly) power that constantly undermines the invisible hand. For that reason, Smith was adamantly opposed to the idea of limited liability, to corporations in other words. In short, firms were essential as loci of divided and synchronised labour but their ultimate contribution to society was predicated upon being kept small, free of the division between ownership and control that is the feature of modern corporations and, lastly, engaged in constant, cut-throat competition with one another.

Karl Marx

Marx posed a simple question: Where do firm profits come from? If Smith’s beloved competition works well, prices will crash to the level of per unit costs and profits will wither. So, is profit only possible when the market is insufficiently competitive? His answer was in the negative. He believed that firms can profit even when competition is as cut-throat as Smith had wanted. The key to his theory was the dual nature of labour: Employers hire labour time from selected employees (and pay a competitive wage for it – a standard price for labour time that is determined at the labour market) but, once production begins, firms receive from workers another kind of labour: the employees’ energy, work, ideas etc. Notice the ‘gap’: employers they pay for ‘labour time’, for which there is an established market and a market-determined price (the wage), but receive something different – labour’s fruits, which can and, indeed, must have a value in excess of that of the ‘labour time’ firms pay for. That difference, between the value of the type of labour received and the type of labour paid for, is the source of profit (and is known in the ‘trade’ as surplus value). In short, for Marx, firms operate as profit machines, through the generation of surplus value. Pure exchanges cannot sustainably generate profits since arbitrage is bound to eat into the latter. Firms are the realms of extractive power. It is where surplus is generated, before turning into rent and interest payments, with the residual equalling the firm’s profit.

Joseph Schumpeter

Unlike Smith, Schumpeter thought that progress and social well-being could not result from cut-throat competition between small firms that squeezes their profits to zero. He thought, instead, that corporations wielding monopoly (or oligopoly) power were the true agents of progress. For if long term improvement, and ultimately much lower costs, require expensive R&D, only monopoly-oligopoly profits can finance it. Adopting an evolutionary perspective (one that he admits to having borrowed from Marx – even though the two men were politically at odds), he conceived of large corporations as dinosaurs struggling to survive. Most become extinct, victims of upstarts with brighter ideas, better management structures and fresher products. In turn, these upstarts grow large and unwieldy and are, in time, undermined by hungrier, leaner, more innovative competitors. And so on. In short, Schumpeter emphasised the importance of the corporations’ monopoly-oligopoly power from the perspective of cost-destroying innovations. Firms, corporations in particular, are seen as case studies of central planning in a see of competitive markets. While Schumpeter would say that companies like GM or Microsoft were not much different to Soviet style planning operations, he hoped that the marketplace within which they functioned would impose upon them Darwinian pressures that would, eventually, push them into the list of extinct outfits, giving space for newer, fresher corporations. Then again, in his famous Capitalism, Socialism and Democracy, Schumpeter expressed grave doubts about a society whose future depends on a corporate culture that functions in hierarchical terms that are not so much different from the logic of the former Soviet Union’s Gosplan (the central planning agency).

Ronald Coase

Coase was the first economist to pose unequivocally the question that my title paraphrases: Why firms? What are they good for? Why should an entrepreneur want to hire employees rather than subcontract an activity or service to someone else? While both Marx and Schumpeter had already given interesting answers to this question, Coase’s own answer is interesting also. He pointed out simply and convincingly that the cost of subcontracting a good or service, through some market, may be much larger than the cost of producing that good or service internally. He attributed this difference to transactions costs and explained that they were due to the costs of bargaining (with contractors), of enforcing incomplete contracts (whose incompleteness is due to the fact that some activities and qualities cannot be fully described in a written contract), of imperfect monitoring and asymmetrically distributed information, of keeping trade secrets… secret, etc. In short, contractual obligations can never be perfectly stipulated or enforced, especially when information is scarce and unequally distributed, and this gives rise to transaction costs which can become debilitating unless joint production takes place within the hierarchically structured firm. Optimal corporation size corresponds, in Coase’s scheme of things, to a ‘point’ where the net marginal cost of contracting out a service or good (including transaction costs) tends to zero 

4. Spontaneous order via time allocation and team formation: Valve’s way

A corporation that tries to function as a type of ‘spontaneous order’ (i.e. without an internal system of command/hierarchy) seems like a contradiction in terms. Smith’s and Hayek’s spontaneous orders turn on price signals. As Coase et al explained in the previous section, the whole point about a corporation is that its internal organisation cannot turn on price signals (for if it could, it would not exist as a corporation but would, instead, contract out all the goods and services internally produced). So, if Valve’s own spontaneous order does not turn on price signals, what does it turn on?

The answer is: on time and team allocations. Each employee chooses (a) her partners (or team with which she wants to work) and (b) how much time she wants to devote to various competing projects. In making this decision, each Valve employee takes into account not only the attractiveness of projects and teams competing for their time but, also, the decisions of others. The reason is that, especially when insufficiently informed about projects and teams (e.g. when an employee has recently joined Valve), an employee can gather much useful information about projects and teams simple by observing how popular different projects and teams are (a) with others in general, (b) with others whose interests/talents are closer to their own.

Just like in a marketplace, everything in Valve is in flux. People move about (making use of their desk’s wheels), new teams are formed, new projects are concocted. All this information is observable by the naked eye (one notices an empty spot where David’s desk used to be, and then finds out that David moved to the 4^th floor to work with Tom, Dick and Harriet), on the company’s intranet, in cross-team meetings where teams inform each other on what they are working on). People learn constantly, both by observing and by doing, the value to them of different projects and teams. These subjective values keep changing, as the time and team formation signals that are emitted by everyone else are updated.

The idea here is that, through this ever-evolving process, people’s capacities, talents and ideas are given the best chance possible to develop and produce synergies that promote the Common Good. It is as if an invisible hand guides Valve’s individual members to decisions that both unleash each person’s potential and serve the company’s collective interest (which does not necessarily coincide with profit maximisation).

5. Valve in the historical context of self-managed co-ops

There are two kinds of non-capitalist firms: (a) Mutual, co-op like, firms whose ownership is formally dispersed among members (who may be customers, employees or both); and (b) Valve (or similar companies) where management is completely horizontal (i.e. the company is boss-less) even if ownership is held in the hands of a selected few.

Valve is, at least in one way, more radical than a traditional co-operative firm. Co-ops are companies whose ownership is shared equally among its members. Nonetheless, co-ops are usually hierarchical organisations. Democratic perhaps, but hierarchical nonetheless. Managers may be selected through some democratic or consultative process involving members but, once selected, they delegate and command their ‘underlings’ in a manner not at all dissimilar to a standard corporation. At Valve, by contrast, each person manages herself while teams operate on the basis of voluntarism, with collective activities regulated and coordinated spontaneously via the operations of the time allocation-based spontaneous order mechanism described above.

Regarding remuneration, both the co-op model and the Valve model differ substantially from conventional capitalist corporations. Capitalist firms is organised along the principle that the owner is the residual claimant once factors of production are paid their market-determined prices. E.g. shareholders are assumed to retain dividends that equal total revenue minus fixed costs, minus labour costs, minus interest on capital borrowed, minus planned investment, minus all other variable costs. Employees thus receive income that is determined by the conditions of the labour market at large and which is a reward for their labour time (estimated at the market determined price of it). Bonuses blur the distinction between profit and wage income but, to the extent that they constitute a stable proportion of one’s wages (and are incapable, courtesy of imperfect monitoring, of being properly tied to individual marginal or average productivity), they can be thought of as part of wage income (except for CEOs and the like whose position of power over the shareholders creates the well known tensions resulting from the ‘managerial revolution’, which saw ownership separate from hierarchical control). In contrast, co-ops and Valve feature peer-based systems for determining the distribution of a firm’s surplus among employees. [Before writing more in this, especially regarding Valve, I shall need to become better acquainted with the peer-review based process of determining bonuses. Watch this space!]

The standard arguments against co-ops, by the opponents of such ‘socialist’ experiments, are centred upon the spectre of malfeasance, the substandard access to the capital markets (as investors are wary of co-ops), lack of scalability etc.[3] Some of these, one imagines, carry over to Valve’s model of horizontal management. Let’s see which do:

(a)  Malfeasance

Without a boss overlooking one’s work, what stops a Valve employee from dosing off? The answer is: a combination of social conventions (recall Hume’s point about their ‘utilιty’ as coordinating devices within a spontaneous social order), of the fact that Valve employees (by definition and design) only work on projects that interest them, and (last but not least) a very careful screening process the purpose of which is to ensure that Valve admits to its ranks self-motivated people who prefer to do something exciting than to be idle. 

(b)  Substandard access to capital markets

Valve is admittedly a special case, in that it does not depend on access to capital markets courtesy of a healthy bottom line which allows the company to source its investment, quite adequately, in its own revenue pool. Having said that, I see no reason why a company with this structure would not be able to tap into financial capital. Given that its ownership is not dispersed, unlike that of a mutual firm or co-op, investors should only be concerned about company earnings which, in turn, depend on the success that Valve employees have in procuring the alternative spontaneous order that I mentioned before.

(c)  Scalability

Hayek’s large claim for the market mechanism as the precursor of a socially benevolent spontaneous order was that it was, unlike planning/planned mechanisms, infinitely scalable. Is Valve’s corporate model infinitely scalable?

From what I gather, Valve’s leading lights thought (and may still maintain this view) that the answer is no. That Valve would reach an optimal size and then hit problems with its boss-less, horizontal, anarcho-syndicalist structure. Be that as it may, the current size of Valve (pushing 400 souls) has exceeded expectations of what that optimal size might me without any evidence that it has actually been reached. Could it be that that optimal size will not be reached for a long while, as long as the social conventions of its community of employees are preserved? Could it be that Valve’s alternative ‘spontaneous order’ is scalable if not infinitely at least indefinitely?

Only time will tell. However, as long as the free allocation of individual time to various projects and teams functions reasonable well, as a mechanism for signalling to Valve employees how to make decisions about what to work on in a manner that promotes the production of a decent experience for Valve’s community and customer base, there is, at least in principle, no reason to expect that the Valve model is limited to certain size and scale confines. 

6. Conclusion: What Valve signals for the future

Having spent a few months working at Valve, I can testify to the truth of its own self-image as a boss-less corporation. As a political economist who spent a great deal of time debating alternatives to capitalist corporations, working at Valve is affording me a valuable opportunity to watch one such alternative corporation in action. In this post, I attempted to place Valve’s quirky management structure in the context of time-honoured debates and perspectives. Central to my narrative of ‘Valve’s way’ was the notion of an ‘alternative spontaneous order’: one that emerges within a corporation (as opposed to within a market-society) on the basis of individual time allocations (as opposed to price signals). The tantalising thought arose, during my musings, that this organisational structure may be as scalable as a market mechanism (assuming that the right technologies are in hand, ensuring transparency and low communications’ costs within the company).

There is one important aspect of Valve that I did not focus on: the link between its horizontal management structure and its ‘vertical’ ownership structure. Valve is a private company owned mostly by few individuals. In that sense, it is an enlightened oligarchy: an oligarchy in that it is owned by a few and enlightened in that those few are not using their property rights to boss people around. The question arises: what happens to the alternative spontaneous order within Valve if some or all of the owners decide to sell up? Granted that Valve’s owners do not intend to do this, the question remains, at least at the theoretical level.

One possibility is that Valve will divide and multiply into a number of different Valve-like companies, as its talented employees leave for greener pastures and, possibly, with the intend of re-creating the horizontal management structure that they grew happily familiar with. Another possibility is that the owners may actually sell their stake to Valve employees, thus combining the features of a co-op with the Valve management system.

Whatever the future of Valve turns out like, one thing is for certain – and it so happens that it constitutes the reason why I am personally excited to be part of Valve: The current system of corporate governance is bunk. Capitalist corporations are on the way to certain extinction. Replete with hierarchies that are exceedingly wasteful of human talent and energies, intertwined with toxic finance, co-dependent with political structures that are losing democratic legitimacy fast, a form of post-capitalist, decentralised corporation will, sooner or later, emerge. The eradication of distribution and marginal costs, the capacity of producers to have direct access to billions of customers instantaneously, the advances of open source communities and mentalities, all these fascinating developments are bound to turn the autocratic Soviet-like megaliths of today into curiosities that students of political economy, business studies et al will marvel at in the future, just like school children marvel at dinosaur skeletons at the Natural History museum. I trust that Valve’s organisation will become, if not a central chapter, at the very least an important footnote in this historical turn.

One reader, for example, wrote to say that more often than not she used Steam in order to ‘give away’ to fellow players items that she had in her backpack (and which were surplus to requirements). Or to indulge in gift exchanges with them. The point of those communications was that, if people are prone to effect ‘trades’ that are, in reality, ‘give aways’ or some form of ‘gift exchanges’, the computation of relative prices utilising the observed exchange ratios from such ‘trades’ will be badly compromised (as these exchange ratios are, despite their social significance, economically meaningless and, therefore, perfectly capable of skewing our computed relative prices).

My immediate answer is to acknowledge their point and to answer that we are doing our best to leave out of our computations exchange ratios that are clearly economically senseless. Of course, this also means that we, as analysts, exercise a great deal of arbitrary discretionary power (in deciding which ‘trades’ to ignore) while formulating our estimates of relative prices. Nevertheless, my main rejoinder here is that, while I acknowledge the point, …such is (economic) life! Even in ‘real’, or analogue, economies, many agreed prices between buyers and sellers reflect factors beyond supply, demand and bargaining power. Why would, or should, digital economies be any different?

These thoughts led me to a more general, almost philosophical, consideration. Adam Smith, the ‘patron saint’ of economists, believed that the foundation of all economic activity was none other than the human “…propensity to truck, barter, and exchange one thing for another.” (See Book 1, Chapter 2 of his Wealth of Nations, 1776). Was he right?

It depends on what he meant by ‘exchange’. If he meant the sort of exchanges that occur in a stock exchange or in some anonymous marketplace (including your local supermarket), then Smith was profoundly wrong: Multi-person (as opposed to Robinson Crusoe-like) economic activity began life, both among animals and humans, on the basis of fully socialised reciprocity. As I argue in Section 1 below, the history of human economies is built on cooperative non-market interactions – even money was not ‘invented’ as a mere lubricant of market exchanges (despite what most economists think). Exchanges are never of the purely market sort envisioned by economic theorists and free market enthusiasts (see Section 2). Thus, the idea that our economic history can be understood in terms of some natural instinct for pure market trades is, at least for me, false.

Setting aside, for the moment, the pertinence of Smith’s hypothesis about the foundations of our ‘analogue’ social economies, could it be that Smith’s theory is spot on in the case of digital economies? Surely, when people trade on Steam, or within other video game communities, they are propelled by an instinct to “truck, barter and exchange” motivated purely by self-interest. In this blog post I present my tentative conclusions on this question. But first, let us look carefully at both sides of the argument about the nature of economic activity and the meaning of exchange.

1. If not barter and exchanges, what was the essence of human economic activity (before, that is, multiplayer computer games came along)?

Smith presupposed that humans, from a very early stage, based their economic activity on trade. He imagined that pre-historic hunters, gatherers and shepherds would gather together, or meet in pairs, and indulge in exchanges of arrowheads for tanned leather or of rabbits for chunks of stag meat. That, at some point, tired of being at the mercy of the double coincidence of want, they homed in on some numéraire–asset (e.g. salt, cowries or some precious metal) which they began to treat as a universally accepted currency for the purposes of greasing the wheels of trade.

While this story is nicely satisfying, it is most probably factually wrong. Anthropologists of note have demonstrated that the evidence points to another evolutionary process that yielded money. One that was based not on money’s utility as a lubricant of trade but, rather, as a unit of accounting for debt! Take for instance the first archaeological evidence of accounting books, dating to 3500BC and unearthed in Mesopotamia (contemporary Iraq). They come in the form of tablets on which ancient accountants had painstakingly carved a log of who owed what to whom, of how much grain each resident within some temple jurisdiction had stored at the communal warehouse, of how much barley was owed to those working in the temple. What is beguiling is that the unit of account often took the form of silver coins that, in fact, did not even circulate (or had not even been minted). Indeed, everyday use of coins as a means of exchange was not witnessed for several thousands of years after it was used to record debt obligations…

If I am right, the abundant archaeological and anthropological sources at our disposal suggest that pure exchange was not civilisation’s foundation, despite Adam Smith’s conviction. No, what set us on a course to modern societies were social conventions of production and distribution based on hierarchies, obligations, social norms that determined individual and caste entitlements and, of course, organised violence. Even though we developed money very early on, it did not buy much.

2. Regardless of the origins of money, have pure exchanges taken over all economic activities?

Even in today’s highly monetised society (where almost everything is for sale), it is not hard to see remnants of the older societies, in which money did not buy much. Consider the following scene: It is Thanksgiving. Mum has slaved over a hot stove all day to produce the turkey for everyone and, at the end of the day, it is expected that each ‘recipient’ of her ‘gift’ will help with the washing up. One family member declares that he will not be participating in the clean up and asks: “How much should I pay you to get out of my washing up duties?” The answer, most probably, is: “Get lost!” I use this example to illustrate that it is perfectly possible to be utterly familiar with money, to use it all the time, but to refrain basing decisions on what to produce and for whom exclusively on monetary transactions. Indeed, my argument above has been that civilisation was built on a division of labour that had little to do with pure exchanges. It is only in the past two or three centuries that impersonal pure exchanges have taken over. And even now, it has not done so fully.

3. Pure and impure (or contested) exchanges

What is a pure exchange? It is an impersonal market exchange where the relationship between the buyer and the seller is fully reducible to the objects exchanged (e.g. apples and oranges) and to the exchange ratio (e.g. two apples for one orange). Moreover, it is a relationship that expires the moment the transaction is completed.[i]

Impure exchanges, in contrast, involve social obligations and thoughts such as “I shall do X for Jill not because of what I expect Jill to do in return for me but of what she would do if she were in my place.” In impure exchanges there is no expectation of equivalence of that which is being exchanged (e.g. your mother does not need to feel that her labour, to produce the turkey, is somehow equivalent to that you will be putting into the washing up later). In pure exchanges, by contrast, traders worry about little else than being ‘short-changed’. The market rules supreme when ‘equivalence’ in values traded is the name of the game.

Of course part and parcel of impure exchanges is hierarchy. At Thanksgiving, mum pulls rank and everyone else does as they are told. Hierarchy involves exchanges between unequals which are more often than not supported by social norms and (unequal) gift exchanges reflecting the ‘givers’ social status. In many societies, for instance, a ruler would often bestow a precious gift upon one as a means of deepening their recipient’s subservience.

For centuries, if not millennia, the pure and the impure coincided in the exchanges that kept the world going. Even though money was often involved, fully monetised, pure, exchanges did not ‘arrive’ until fairly recently. When exactly? Around three centuries ago and, in particular, after land and labour were commodified (following, e.g., the conversion of bonded peasant labour into free labourers working for a wage).

Today, we have come as close as possible to creating a realm of pure exchanges. When you walk out of the supermarket checkout, your social relationship with the ‘seller’ (who is not, of course, the checkout employee) is non-existent. It is as close to a pure exchange as it can be. The financial markets are the ultimate realm of pure exchanges, especially when trading is done not even by humans but by algorithms (or algos) trading with one another on our behalf. And yet this is not to say that we have a social economy predicated entirely on pure exchange.

Take for instance the employment contract through which employees ‘sell’ their labour to employers. By definition, this is an impure transaction. Think about it: the employee cannot simply ‘leave’ after selling her ‘asset’ (i.e. her labour) to the employer. She must stay on the premises while her labour is ‘diffused’ through the company’s network. So, as long as people are hired by employers, our analogue economy can never be a realm of pure exchanges. Something other than “trucking, bartering and exchanging” must be going on.

4. Steam trading: A realm of pure exchanges?

Digital economies, like Steam’s exchange platform, come closer to Adam Smith’s concept of an economy that sprang from a penchant for pure exchanges. People meet up online, enter into mutually beneficial trades with minimal other social obligations to one another, bear no debts (monetary or social), and walk off with whatever item they managed to acquire (via bartering) without any need to maintain a ‘relation’ with the person they bartered with. An economy created as if in the image of Adam Smith?

Not quite. The exchanges that we observe on Steam are not exactly pure. As readers have perceptively remarked, many exchanges are highly impure. People simply use Steam in order to unload onto others items from their backpack that are surplus to requirements. Often, they will accept remarkably low ‘value’ in return. Value equivalence, a prerequisite for trading-proper, is simply absent. But then again, this is how trade began and continued to be practised for thousands of years: People sold goods that they produced, or gathered, over and above their ‘planned’ (i.e. needed) volumes. It is not that they produced these goods in order to exchange them (the very definition of a commodity being a good produced in order to be traded) but, rather, they sold the quantities that ended up being surplus to requirements. It is no exaggeration to suggest that, until the rise of industrialisation and market societies, less than 5% of goods produced were commodities. So, until a couple of centuries ago, most trade happened because of unexpected, or unplanned, surpluses: very much like those in the TF2 economy!

In short, Steam trades are not always pure exchanges happening in some moral-free zone where social obligations are perceived to be non-existent. An unspecified (and impossible to compute accurately) number of trades take place at exchange rates that do not reflect the relative bargaining of buyer and seller but, instead, are determined by other social and gaming factors. In technical terms, this means that, while our arbitrage data is not affected (since the volume of arbitrage opportunities is independent of the reasons for which some items are sold cheaply and resold expensively), our relative price estimates are. Ideally, we would like to have some ‘gift exchange’ radar that alerts us to all instances of Steam ‘trading’ where people are far from trying to get the best possible ‘bargain’ for themselves. If we possessed such a radar, we would use it to decide which trades to turn a blind eye to when computing relative prices. Of course, that ‘radar’ is missing. So far we are utilising crude methods of ‘visual’ inspection, leaving out of our calculations those relative prices that seem, economically, silly. Clearly, we need to work on coming up with such a radar. Any suggestions from you will be most welcome…

An interesting twist to this debate is added by the opportunity that TF2 players have to buy gifts for anonymous strangers by purchasing a Secret Saxton from Steam. (See here for information on gifting, for those unfamiliar with it. In brief, purchasing a Secret Saxton immediately sends an item to some random player within the digital vicinity of the ‘giver’, followed by a public statement of who was the ‘giver’). The popularity of these Secret Saxtons provides ample evidence that TF2 players are replete with motives that go well beyond the urge to “truck, barter and exchange”.

As the following diagram reveals, random gifts to fellow ‘strangers’ are frequent and peak heavily around a two-day period during which we have ‘learnt to believe’ that we ought to give presents to people with whom we have some form of social relationship with. Hardly evidence that those trading on Steam are only indulging in ‘pure’ exchanges, i.e. that they are guided by nothing more than the pursuit of value equivalence.

Recapping, gifts are an important part of the TF2 economy and this, on its own, casts doubt on the purity of all other exchanges and, by association, on our relative price estimates. Our technical difficulty regarding the latter is that, unlike the case of gifting via purchases of the Secret Saxton item (for which we have perfect data), gift exchanges on Steam (as confirmed by readers’ messages) must be prevalent and truly capable of spoiling our data on relative prices.

You may recall that in my previous post, I made a big deal out of our finding that no item emerges as a common currency, a numéraire. Our close study of the TF2 economy revealed that there are times when different items are traded most frequently in different periods. If one item had ‘evolved’ into currency status, that item would have been the most traded all the time. Confounding my expectations that keys would play that role in TF2, Steam trading data shows that there are five or six items which alternate as currencies. How come? Why does one item within the TF2 economy not evolve into a currency given that everyone’s (trading) experience would improve (in terms of ease of ‘closing’ a mutually beneficial trade)? One possible explanation that the preceding discussion is pointing to is this: Because Steam trading, at least of TF2 items, are instances of impure exchanges; that is, trades that are not fully guided by the principle of trading items of equivalent subjective values. Norms of the social valuation of one item relative to another, beliefs of what one is ‘entitled’ to expect to receive for some valuable item (as opposed to what one actually would be happy to receive in exchange for that hat), expectations of a continued social relationship between buyer and seller – all these ‘impurities’ would, if indeed present, prevent the evolution of one item into the role of common currency.

Last, but not least, the impossibility of using a potential item in order to account for debts on Steam trading (unlike in Mesopotamia), offers another clue as to why no item dominates as the game’s currency unit.

5. Conclusion

Many economists believe that philosophising over the nature of exchanges is a luxury they do not need in order to analyse and understand an economy. They are wrong. The nature of exchanges, whether they are pure (i.e. asocial) or impure (replete with social norms and part of intertemporal social relations), makes a difference when it comes to predicting economic activity. Thus, to understand the exchanges we observe on Steam, it is crucial that we grasp the network of social relations within which they are embedded. The prevalence of gifting and the fact that no specific item has emerged as a form of money in trades of TF2 items should alert us to the intriguing social conventions that are part and parcel of our community’s trading decisions. How will these conventions change or mutate when participants are given the capacity to buy and sell, among one another, using real dollars? Would it make a difference if any dollar profit made through such trades can be taken out of Steam (i.e. monetised)? I suspect the answer to these questions are in the affirmative. But we must wait and see.

One of the problems of living in the analogue world is that these concepts (e.g. arbitrage and equilibrium) are extremely hard to pin down. No one has enough information on how actual prices diverge from their ‘equilibrium’ level so as to be able to measure, or to visualise, the potential for arbitrage. All we can do is guess what it might be. Not so in our digital economies. The following diagram, for instance, captures the room for arbitrage (what we call an Index of Arbitrage Potential for Steam trades of Team Fortress 2 items) as it arose during the period 13^th November 2011 to 23^rd May 2012.

The peaks represent moments when there was a great deal of room for arbitrage (i.e. for buying low and selling high), while the line’s thickness reflects the volume of actual trades. It is no great surprise that these peaks coincided with major new releases and sales (e.g. the Christmas sale) that the community required some time to price properly.  Where did this Index of ours come from? How come we could compile it for our economy when no economist can compile a similar index for the ‘real economy’ out there? The answer to the second question is simple: Unlike the analogue economy (where we can at best sample some prices at discrete points in time), at Valve we have all the real time data there is, courtesy of Steam: a peculiarly sophisticated barter economy. Let me explain why I am calling it ‘peculiarly sophisticated’ before explaining how we put together our graph above.

A peculiarly sophisticated barter economy

Steam enables Valve’s gamers to trade freely with one another, effectively to establish a substantial economy in which thousands of items, also imaginable as assets, are exchanged for one another. This is a typical barter economy, in that every exchange necessitates a double coincidence of wants (i.e. when Jack offers Jill some Team Fortress 2 hat in exchange for a couple of keys, the trade will go ahead if, at the same time, Jill also prefers that particular hat to her two keys).

Barter economies are cumbersome precisely because they require this double coincidence of wants before any bilateral trade proceeds. For this reason, throughout history, whenever the number of transactions (and ‘assets’) grew in number, one of those assets soon emerged as a numéraire – a basic form of money that is. Once the numéraire acquired currency, suddenly the prerequisite of some double coincidence of wants vanished and people could trade anything for the numéraire–asset which they could then use in order to buy whatever else tickled their fancy. In short, as economies grew in sophistication, they ‘monetised’ and ceased functioning on the basis of barter. This is why never in history have we witnessed truly sophisticated barter economies (for reasons similar to why we have not developed hugely sophisticated training wheels for professional cyclists).

Initially, I had expected that a similar pattern would be replicated in digital economies, like Valve’s. I was expecting to find that some item or asset would emerge as currency in the context of games such as Team Fortress 2. However, a close study of our Team Fortress 2 economy revealed a more complex picture; one in which barter still prevails even though the volume of trading is skyrocketing and the sophistication of the participants’ economic behavior is progressing in leaps and bounds. 

What is an economic equilibrium?

Those of you unlucky enough to have suffered the privilege of studying economics 101, will recall our fixation with something we call equilibrium. Why is equilibrium such a central concept in economics? The simple answer is that, without it, we economists stand no chance of explaining anything, let alone predicting (prices, quantities, etc.).

The idea of an equilibrium sprang up, like most scientific ideas, from physics. Suppose that you see a rock rolling down a mountain. Can you predict its path? Or, equivalently, can you predict its final resting point? If you can, then you have a pretty decent idea of its actual path. Well, this ‘resting point’ is what we mean by equilibrium: the point at which some ‘system’ will reach a resting place; a place in which there will be no tendency to carry on ‘moving’. Back to economics, suppose that we are witnessing the price of oil increasing, after (say) a period of relative stability. Will it stop at some level? Which level will that be? In other words, will it reach a new equilibrium, and if so what is the equilibrium price?

To complicate things a little, both in Nature and in some economy, an equilibrium can be either static or dynamic. A static equilibrium means no change. The ‘system’ under study is in complete standstill. Like the rock that stopped rolling. A dynamic equilibrium, by contrast, entails movement but of the sort that is eminently predictable, periodic. For example, the Earth’s orbit around the Sun (while neither the Earth or the Sun are stationary, the Earth’s orbit is). Or the demand for toys which, predictably, peaks before Christmas, every Christmas.

Equilibrium in a barter economy

Consider a small scale version of an economy like that of Team Fortress 2 (TF2) – the first Valve economy that I had the pleasure of studying. Suppose that there are four tradable items only: Some laser gun (G), one type of hat (H), earmuffs (E) and keys (K). Now suppose that we observe that players trade these items in the following proportions, or exchange rates (also known in the economics trade as ‘relative prices’):

• 2 hats for 1 laser gun
• 1 key for 2 laser guns
• 3 earmuffs for 1 laser gun

Question:       Recalling that equilibrium is reached when there is no further room for arbitrage, how many hats should 1 ear muff buy if this economy is to be in equilibrium?

Answer:          From the ‘numbers’ above, we know that, in terms of exchange values:

Value of 1 laser gun = value of 2 hats = value of 3 ear muffs = ½ a key

OR

1 key buys 4 hats, or 6 ear muffs, or 2 laser guns.

Thus, the relative price of hats to ear muffs ought to be 4-to-6, which is the same as an exchange ratio of 2:3 hats to earmuffs, or 3:2 earmuffs to hats. In terms of a table, or matrix, the above reduces to the simple question: What should the missing entries be (i.e. the numbers in the red, blue and orange cells) if this tiny economy can be said to be in equilibrium?

We have already found the missing number in the case of the red cell: It is 3/2, i.e. the exchange ratio, or relative price, 1.5 earmuffs to one hat (or 2 hats for 3 ear muffs). Before moving to the missing numbers in the blue and orange cells, let’s first make sure we understand that unless the number in the red cell is 3/2 there will be room for arbitrage – which, in turn, means that some entrepreneurial person will try to exploit, with the result that the prices in the first row will end up changing.

Suppose that the number we actually observe (from our trading data) in the red cell was 3 (as opposed to 3/2). What would that mean? It would mean that a smart Jill, some fictitious player, could do the following starting with, say, 6 earmuffs:

1. Jill could trade her 6 earmuffs for 2 laser guns (since, from the first row, we know that she needs 3 earmuffs to get 1 laser gun)
2. Jill could then trade these 2 laser guns for 4 hats (since, again from the first row, we see that the exchange rate is 2 hats per laser gun)
3. Finally, if the number in the red cell is 3, she could trade each of her 4 hats for 3 earmuffs – ending up with 12 earmuffs.

This is a typical case of arbitrage. Jill starts with 6 earmuffs and, just by bartering, she ends up with more earmuffs than she started off with. While this is great for Jill, economists believe that arbitrage opportunities of that sort cannot survive for long. Why? Because, if these opportunities for gain (without pain) are freely available, they will be exploited. So, others will emulate Jill, trying to trade earmuffs for laser guns and then laser guns for hats, before trading hats back to earmuffs. But all these offers of earmuffs (corresponding to what Jill did in the first step above) will exert downward pressure on the relative value of earmuffs. E.g. it will cause players selling their laser guns to demand more earmuffs for each of their laser guns. Thus, the price of earmuffs will fall (relative to laser guns) and, therefore, the opportunity to end up with more earmuffs (through selling them before buying them again) will disappear.

In short, as players take advantage of arbitrage opportunities, the economy tends to equilibrium and, when it gets there, there are no arbitrage opportunities left! What would our economy look like in such a state of equilibrium? The following tables answer the question: Each relative price in the oval shape must equal the relative price in the rectangle divided by the relative price in the triangle.

More generally speaking, in economies like (our TF2 one) with many, many items that are being traded, say N, there will be (N=1)N/2 relative prices; e.g. even if we only had 100 assets, we would end up with 4950 relative prices. Imagine the complexity of the TF2 economy where we have more than 35 thousand items. We are talking about more than 600 million relative prices at any one point in time. What would an equilibrium look like? The answer is less complex than you may think. This is what our N by N matrix of relative prices looks like when assuming that keys (k) are the N^th item:

Just like in the simple 4 item example above, our prices are in equilibrium when the following equalities hold – which are no more than an extension of the conclusion above that each relative price in the oval shape must equal the relative price in the rectangle divided by the relative price in the triangle:

Why care about equilibrium?

The simple answer is because it makes our lives (as economic analysts) much, much easier. Take again the simple 4-item example above, in a state of equilibrium:

The beauty of equilibrium is that it makes it possible for us to quote only one price per item. Indeed, the matrix above can be reduced to a simple menu list which gives us the price of laser guns, hats and earmuffs in terms of number of keys necessary to purchase one unit of each:

Suddenly, instead of 6 prices we have 3. And in the case of 99 items, the number of prices reduces drastically from 4950 to just… 98 (one per item, excluding the keys that have no price, as they are the effective currency).

Should we expect the economy to be in equilibrium?

We wish! But if we assume, as economists tend to, that equilibrium prevails most of the time we are inhabiting La La Land. Indeed, the first great economists (people like Adam Smith and David Ricardo) never thought that an economy would ‘equilibrate’; that it would ever reach equilibrium. They just hoped that competition will cause economies to tend to an equilibrium, which is quite different to saying that they will actually get there. So, to cut to the chase, we should never assume that our economy is in equilibrium.

Now, the beauty of digital economies is that we have all the data at our disposal. We can actually observe how far or how close to equilibrium our economies are. So, one of the first things I did at Valve was to put the TF2 economy under the microscope to see whether it is in equilibrium or not. Guess what: it is nowhere near it. So, folks, it is official: There is plenty of room for arbitrage. Moreover, this arbitrage window varies in size constantly – as we shall see below via the medium of some nice graphs.

But first, to measure the arbitrage potential, or window, we needed to develop a method for assigning one price per item even though our economies are hardly ever in equilibrium (a fact that, according to what I just wrote above, should rule out assigning one price per item). This is how we did it:

Measuring the relative prices/values of the TF2 economy

Having observed that the TF2 economy is never in equilibrium  long enough for us to be able to derive one price per item, we asked ourselves: Is it possible to measure the size of our economy? To offer a valuation of some hat or other item? To answer any of these questions, we had to find a way of pinpointing one price per item (e.g. some hat) when, in reality, there is not one but many (e.g. one in terms of laser guns, one in terms of keys, one in terms of earmuffs and, to boot, these prices are in conflict with one another – thus giving rise to arbitrage opportunities). How could we do this?

Suppose that, returning to our trusted 4-item example, we have the following disequilbrium prices (averaged out over a period of, say, a week):

Because we are in disequilibrium, it makes no sense to take the last column as a vector of our relative prices for G, H and E. We need to take into consideration the fact that the other numbers (in the other columns) are inconsistent with the last column and pack important information about the value of each item (that we should not throw out). Here is what we did in order to compute single price estimates for each item:

We began by noting that, if the economy were in equilibrium, the following equations would hold:

Then we observed how many times, during the same period of observation (week in our case), guns were traded for keys (say N_GK), guns were swapped for hats (N_GH), guns for earmuffs (N_GE), hats for keys (N_HK) etc. Beginning with the item that was traded most often, we computed the price of guns as its exchange ratio with that most heavily traded item. E.g. if keys were the most traded, we would define the price of guns as . Next to compute the price of hats in terms of keys we would use the equation (see above) =, which would have held in equilibrium. But because we are not in equilibrium, we augment it by the relative frequency of trades as follows:

Estimated price of hats in terms of keys =

In other words we weighed the two sides of the equation that would have held in equilibrium in a way that reflects which of these bilateral trades were relatively more frequent (and thus influential). In this manner, and after having dealt with a significant number of computational issues that I shall not bother you with here, we ended up with a method deriving a list (or vector) of prices per item. What were they expressed in? They were expressed in something I call notional keys; i.e. the ‘keys’ that would have been observed if our economy were in equilibrium. In other words, a made-up currency that converges to the actual keys of the TF2 economy when the latter approaches to equilibrium, as arbitrage opportunities vanish.

And the result? Here is a graph depicting our estimates of the (relative) price of three popular TF2 items: earbuds (in red), Bill’s hat (in blue) and refined metal (in purple). [Note that this diagram pertains to the period between November 2011 and 1^st June 2012.]  

Arbitrage opportunities come and go in the TF2 economy

So, the time has come to explain the derivation of our Index of Arbitrage Potential as it appeared in the diagram with which this post began.

In the preceding analysis (as evidenced by the last diagram) we managed to compute one price per item in the TF2 economy. From these it was easy to derive our Index of Arbitrage Potential. Here is how we did it: We have already worked out that the following equations must hold in equilibrium:

By computing the extent to which these equations do not hold (by means of computing the least squares of the differences between the left hand and the right hand side of these equations, all added together), we can gauge how far our economy is from equilibrium at any point in time. And we can then graph these against real time, looking out for fluctuations in the presence of arbitrage opportunities as new items (ones not previously priced by the community) enter the game. The result is a series of rather cool graphs, one which you saw at the beginning of this post.

Conclusion

When trading on Steam, there is always potential for gaining by buying items cheaply and selling them expensively. By the same token, you may be short-changed, so to speak. In this post I tried to show you how these opportunities and dangers come and go; how they expand when new items or sales are released and then wane as the community learns to price things more consistently (i.e. as arbitrage gives way to equilibrium). I think this is fun to see. The tantalising thought also comes to mind that we could, perhaps, let you see this graph in real time, to guide your trading. Or perhaps not? What do you think?

Before the Euro Crisis erupted in 2009, I was just another economics professor, minding my own little theoretical endeavours, writing obscure papers and esoteric books that only a few hundred nutcases around the world (like myself) would ever read, terribly satisfied in my very own academic cocoon. Back then, I would never even imagine not answering an incoming email.

And then, all of a sudden, as if by the wave of some vengeful wizard’s wand, the tranquility was shattered and I found myself in the midst of an acrimonious Europe-wide debate watched over by millions. (If interested, you may take a look at the blog I have dedicated to these debates here.) It is what, I suppose, happens every seventy years or so when a major economic collapse turns us economists from creatures to be avoided at all cost (especially on TV or around the dinner table) into minor celebrities whose words are eagerly followed by a despairing public. Why me? For two reasons I think. First, because I am Greek and Greece was the canary in the mine (whose death warned the rest of Europe of the impending ‘gas explosion’). Secondly because I am a rather unconventional Greek whose line of argument on the BBC, CNN etc. raised eyebrows – for reasons I shall not bother you with here. Anyhow, my life was transformed overnight.

A side effect of this ‘transformation’ was that my inbox became impenetrable to the human eye, receiving as I did thousands of unsolicited non-spam messages from people with a wide range of fixations – from sharing their world view, to seeking advice on what to do with their investment in some pig farm in the north of Greece, to offering me a share in some far-fetched business venture.

When I read the opening line of the email in question, my finger almost pushed the delete button:

“I’m the president of a videogame company (www.valvesoftware.com).”

I thought to myself: Oh, not another “business proposal” from a crackpot… However, something in my head stopped my finger from pressing DEL while my eyes pondered the next line:

“We are running into a bunch of problems as we scale up our virtual economies, and as we link economies together. Would you be interested in consulting with us?”

I was intrigued. The finger retreated from the keyboard’s right hand side and I read on:

“I have been following your blog for a while… Here at my company we were discussing an issue of linking economies in two virtual environments (creating a shared currency), and wrestling with some of the thornier problems of balance of payments, when it occurred to me “this is Germany and Greece”, a thought that wouldn’t have occurred to me without having followed your blog. Rather than continuing to run an emulator of you in my head, I thought I’d check to see if we couldn’t get the real you interested in what we are doing.”

At that point, I was more than intrigued. I was interested! While the signature did not ring a bell (it read “Gabe Newell, Valve, Seattle, WA USA”), and while I was as ignorant of the world of computer games as one can be (yes, I confess, horror of horrors, that I am not a gamer), the notion that a computer game company has surreptitiously and quite spontaneously created virtual economies that it comprehends as ‘economies’ (which deserve study and regulation) was enough to write back instantly: Yes, I was interested!

By a stroke of serendipity, a few days later, my wife and I were due to embark on a lecture tour of North America, promoting a recent book on the global crisis of 2008. A two-day visit to Seattle was added to the last part of our itinerary. So, after an arduous, albeit satisfying, series of lectures (in various US and Canadian Universities, at the New York Federal Reserve, at Bloomberg etc.), the Valve visit was going to be a two-day relaxing break from normal activities during which to see what these weird computer gamers were up to.

Face to face

Upon arrival in Seattle, Mikael, the driver who picked us up on Valve’s behalf, asked me: “Here for an interview, Sir?” I answered that, no, of course not; that I was just visiting Valve for a couple of days. Little did I know! Upon entering Valve, I was met by a group of mainly young persons, gathered together in a meeting room, presided over by Gabe who took no time before asking everyone to introduce themselves and to explain what they did. Jetlagged and sleepless, and confronted by a wall of information about things that I had no prior experience of (indeed, the last time I had played a computer game was Space Invaders at University in the mists of 1981 or so!), I struggled to keep up. Soon, however, I realised that this bunch of people were not just weird but also wonderful and, to boot, that what they were describing, the digital community they had facilitated into existence, was an economist’s dream-come-true. Think of it: An economy where every action leaves a digital trail, every transaction is recorded; indeed, an economy where we do not need statistics since we have all the data!

Escaping ‘computerised astrology’ – Valve’s allure

For the first time since I switched from mathematical statistics to economics (around 1982), I saw an opportunity for scientific research on some really existing (albeit digital) economy. For let’s face it: Econometrics is a travesty! While its heavy reliance on statistics often confuses us into believing that it is a form of applied statistics, in reality it resembles computerised astrology: a form of hocus pocus that seeks to improve its image by incorporating proper science’s methods, displays and processes. Is this not too harsh a judgment on econometrics?

Not in the slightest. Econometrics purports to test economic theories by statistical means. And yet what it ends up testing is whether some ‘reduced form’, an equation (or system of equations), that is consistent with one’s theory, is also consistent with the data. The problem of course is that the ‘reduced form’ under test can be shown to be consistent with an infinity of competing theories. Thus, econometrics can only pretend to discriminate between mutually contradictory theories. All it does is to discover empirical regularities lacking any causal meaning. To put it bluntly, it is impossible to avoid absurd conclusions such as “Christmas is explained by a prior increase in the demand for toys”. And when we do (avoid them), it is only by accident (or because of a good hunch), as opposed to scientific rigour.

And the reason for this unavoidable failure? None other than our inability to run experiments on a macroeconomy such as rewinding time to, say, 1932, in order to see whether the US would have rebounded without the New Deal (or to 2009 to see what would have happened to the US economy without Ben Bernanke’s Quantitative Easing). Even at the level of the microeconomy, keeping faith with the ceteris paribus assumption (i.e. keeping all other things equal in order to measure, e.g., the relationship between the price of and the demand for milk) is impossible (as opposed to just hard).

In sharp contrast to our incapacity to perform truly scientific tests in ‘normal’ economic settings, Valve’s digital economies are a marvelous test-bed for meaningful experimentation. Not only do we have a full-information set (making sampling superfluous) but, more importantly, we can change the economy’s underlying values, rules and settings, and then sit back to observe how the community responds, how relative prices change, the new behavioural patterns that evolve. An economist’s paradise indeed…

Great expectations?

This is how my relationship with Valve began. While a total ignoramus of the world of video games (as per my confession above), the people at Valve and I discerned a double coincidence of interests. My academic curiosity blended nicely into Valve’s burning desire to serve its gaming community better, through the development of services that are in tune with the community’s needs as gamers but also as traders, developers, participants in something much bigger than just video games.

By studying Valve’s economy, we would have an opportunity to enhance the experience of its customers, in addition to sharpening my own thinking about what makes real economies tick. And as if all this were not enough, there was another incentive thrown into the mix: the opportunity to understand better the remarkable social organisation of production within Valve itself. (But more on this in another post…)

Within hours, an agreement was reached: I would become, in some capacity (that was to be hammered out later), Valve’s economist-in-residence. Valve is not the first video game company to have brought an academic economist on board (e.g. EVE Online were the first to do so, recruiting Eyjólfur Guðmundsson  – whom I would like to thank for making my name sound almost easy-going…). My intention at Valve, beyond performing a great deal of data mining, experimentation, and calibration of services provided to customers on the basis of such empirical findings, is to to go one step beyond; to forge narratives and empirical knowledge that (a) transcend the border separating the ‘real’ from the digital economies, and (b) bring together lessons from the political economy of our gamers’ economies and from studying Valve’s very special (and fascinating) internal management structure.

Starting from today, I shall be committing to this blog weekly reports on our projects, experiences and ideas regarding Valve’s various social ‘economies’.

Welcome to VALVE Economics