Informal Networks, Institutions and the “Soap Opera” Constraint

What is the interplay between informal networks, such as those that facilitate risk-sharing among households, and institutions such as public transfers and formal financial intermediation? Much of the existing literature on informal networks in economics focuses on either altruism or strategic mechanisms for their formation and maintenance. This approach stands in sharp contrast to perspectives from psychology and biology, which emphasize cognitive processes associated with “bonding.” Bonding is social activity which build feelings of altruism and trust that facilitate reciprocal exchange. Findings from psychology demonstrate that bonding is subject to cognitive and time-related constraints that limit the number of group members, a phenomenon I call the “soap opera” constraint. Limits on group membership have received little attention in the economic literature on informal networks. I argue that the recognition of such limits can shed new light on the normative questions about the connection between institutions and private behavior. For example, systems of public transfers can enhance efficiency if they allow people to concentrate their limited capacity for social intrigue on the task of production rather than the sharing of risks. A binding “soap opera” constraint introduces imperfect substitutability between formal and informal mechanisms for risk-sharing, borrowing or redistribution. Recognition of limited capacity for the formation of informal networks throws new light on normative issues associated with public redistribution. While public transfers do supplant private ones, the process of crowding out of private transfers by public ones does not leave economic welfare unchanged. Public income redistribution enables a more refined division of labor in production, which can raise output and economic well-being. _______________________________________ *Department of Economics, Boston College, Chestnut Hill, MA 02167.