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The Formal and the Informal
Written rules and unwritten rules
Humans coordinate behavior and cooperate through a combination of formal rules and informal norms.
—Small groups, including families and small businesses, mostly operate informally. People understand how they are expected to behave and what they are expected to contribute, but these expectations are not spelled out in writing. Expectations are based on group norms that have evolved over time. Norms are reinforced through repeated interactions. Members of a small group are motivated to obey norms by a desire to please one another and not be tossed out of the group.
—Large groups, above the Dunbar number, come to rely on formal rules. These are often written down, in the form of company manuals, position descriptions, organization charts, government laws, and written regulations. People obey formal rules even in one-time interactions with strangers. To some extent, people obey rules because they fear being punished otherwise. They do not want to get fired from their jobs or suffer fines or prison terms at the hands of government. But people also obey rules for internal reasons. They want to be able to think of themselves as social cooperators rather than social defectors.
There are some odd cases that are neither formal nor informal. Tipping the server at a restaurant is an example. You might not know the server personally or expect to interact with that server ever again. There are no formal rules requiring you to tip. Yet most people do so.
When formal rules are absent in large groups, problems often arise. The economist Hernando de Soto, in his book The Mystery of Capital, points out that in cities without clear property rights established by government, people cannot make full use of the places where they live. They cannot safely invest in improvements on their land. They cannot borrow against the value of their land. This sharply restricts their ability to generate and acquire wealth.
In business, a large firm without formal rules will end up with employees acting at cross purposes, intentionally or otherwise. John in sales may engage in transactions that Mary in operations and George in accounting cannot handle. One of the challenges of managing a large business is clarifying accountability and ensuring that all affected departments are on board with every new project and new transaction. Organization charts, training programs for new employees, and company procedures manuals serve this purpose.
In a close-knit group, people tend to find formal mechanisms offensive. I do not want my wife to charge me for doing a load of laundry or pay me to wash the dishes. We should not need to have a written agreement describing how we communicate with one another.
Social media are ambiguous in that they provide some cues that suggest informality and other cues that suggest formality. On our phones, our friends try to act like celebrities and celebrities try to act like our friends.
We process tweets or short videos that we receive as if they come from someone in our close-knit group, even though we may have never met the person in real life. And yet when we encounter content that we find offensive, we wish that the platforms would take formal steps to address the problem.
Are our social media interactions supposed to be shaped by informal norms or by formal rules? We have not answered that question. Maybe there is no answer.
One theory is that formal rules emerge from informal practices. Students walk along a particular stretch of grass on campus, and that is where you build a sidewalk. People tend to use a particular form of contract in transactions involving exchanges of securities, and legislators pass laws (or regulators enact regulations) making such contracts mandatory for securities markets. A business finds that a particular set of steps for completing a sale works well, and it hard-codes that process into its computer system.
Sometimes, neither formal mechanisms nor informal approaches work well. When individuals want to transfer money internationally, they find that the formal mechanisms are riddled with inefficiencies and excess costs. But when they try to use informal methods, there is no one to turn to if something goes wrong. Cryptocurrencies represent a promising solution, with the formal mechanisms embedded in the software design. But so far, in order to use crypto, most people have had to work through intermediaries that have not proven to be reliable. Will governments redesign the formal rules for international money transfers to make the process less cumbersome? Will the crypto market find a way to ensure that intermediaries are reliable? Will some sort of hybrid emerge, in which government-backed and government-regulated crypto intermediaries become the solution?
Or will crypto remain forever in the informal sector of the economy, with no ability to enforce transactions in the physical world? Will its practical use case always be adjacent to criminal activity?
This essay is part of a series on human interdependence.