Plastic Money: Constructing Markets for Credit Cards in Eight Postcommunist Countries

Stanford University Press

Stanford, California

©2014 by the Board of Trustees of the Leland Stanford Junior University.

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Library of Congress Cataloging-in-Publication Data

Rona-Tas, Akos, author.

Plastic money : constructing markets for credit cards in eight postcommunist countries / Akos Rona-Tas and Alya Guseva.

pages cm

Includes bibliographical references and index.

ISBN 978-0-8047-6857-3 (cloth : alk. paper)—

ISBN 978-0-8047-6858-0 (pbk. : alk. paper)

1. Credit cards—Former communist countries.   2. Consumer credit—Former communist countries.   3. Post-communism—Economic aspects.   I. Guseva, Alya, 1974- author.   II. Title.

HG3755.7.R66 2014

332.7'65091717—dc23

2013042646

   ISBN 978-0-8047-8959-2 (electronic)

Typeset by Bruce Lundquist in 10/14 Janson

AKOS RONA-TAS AND ALYA GUSEVA

Plastic Money

Constructing Markets for Credit Cards in Eight Postcommunist Countries

STANFORD UNIVERSITY PRESS

STANFORD, CALIFORNIA

For Judit and Adam

A. R-T.

For Alexey, Dasha and Artyom

A. G.

Contents

Figures and Tables

Preface and Acknowledgments

List of Acronyms

1. Paying with Cards

2. The Transition from a Communist to a Market Economy

3. Payment Puzzles

4. Credit Puzzles

5. The Construction of Card Markets in Hungary, Poland and the Czech Republic

6. Russia, Ukraine and Bulgaria

7. Vietnam and China

8. Conclusion

Appendix 1: Data and Methodology

Appendix 2: Concentration in Banking Over Time

Notes

References

Index

Figures and Tables

FIGURES

1.1 Number of Cards per Capita, 1998–2010

1.2 Percentage of Credit, Debit and Charge (Where Applicable) Cards Issued, 2007

1.3 Card Purchase Volume as Percentage of Total Card Volume (Including Cash Withdrawals), 1998–2009

1.4 Volume of Card Purchases in Total Consumer Payments, 1998–2009

2.1 Average Number of Banks in Each Country Between 1990 and 2011 (Logarithmic Scale)

2.2 GDP per Capita in the Eight Countries 1988–2010 at Constant 2000 USD

2.3 Percentage of Total Income Share Held by the Richest 20 Percent in the Late 1980s and the Second Half of the 1990s

2.4 Household Consumption per Capita 1988–2011 at Constant 2000 USD

2.5 Rate of Official Unemployment 1992–2010 (Percentage of Total Work Force)

2.6a Inflation in China, the Czech Republic, Hungary and Poland (GDP Deflator)

2.6b Inflation in Bulgaria, Russia, Ukraine and Vietnam (GDP Deflator)

A2.1a Concentration of Banking Assets in the Czech Republic in 1995

A2.1b Concentration of Banking Assets in the Czech Republic in 2003 (Top Banks Named)

A2.1c Concentration of Banking Assets in the Czech Republic in 2011 (Top Banks Named)

A2.2a Concentration of Banking Assets in Hungary in 1994 (Top Banks Named)

A2.2b Concentration of Banking Assets in Hungary in 2003 (Top Banks Named)

A2.2c Concentration of Banking Assets in Hungary in 2011 (Top Banks Named)

A2.3a Concentration of Banking Assets in Poland in 1995 (Top Banks Named)

A2.3b Concentration of Banking Assets in Poland in 2003 (Top Banks Named)

A2.3c Concentration of Banking Assets in Poland in 2011 (Top Banks Named)

A2.4a Concentration of Banking Assets in Bulgaria in October 1996 (Top Banks Named)

A2.4b Concentration of Banking Assets in Bulgaria in 2003 (Top Banks Named)

A2.4c Concentration of Banking Assets in Bulgaria in 2011 (Top Banks Named)

A2.5a Concentration of Banking Assets in Russia in 1995

A2.5b Concentration of Banking Assets in Russia in 2003 (Top Banks Named)

A2.5c Concentration of Banking Assets in Russia in 2011 (Top Banks Named)

A2.6a Concentration of Banking Assets in Ukraine in 1995

A2.6b Concentration of Banking Assets in Ukraine in 2003 (Top Banks Named)

A2.6c Concentration of Banking Assets in Ukraine in 2011 (Top Banks Named)

A2.7a Concentration of Banking Assets in China in 1995

A2.7b Concentration of Banking Assets in China in 2003

A2.8a Concentration of Banking Assets in Vietnam in 1995

A2.8b Concentration of Banking Assets in Vietnam at the End of 2008 (Top Banks Named)

TABLE

A1.1 List of Interviews and Field Data

Preface and Acknowledgments

In an often told joke, a physicist, a chemist and an economist wreck their sailboat and find themselves on a desert island. The only food they could rescue is a case of canned beans. As their hunger grows, they consider various options for how to get the beans out of the can. The physicist proposes dropping a rock from a tree to crack the can, but the others think this would be too messy. The chemist suggests using salt water to get the can rusted enough to open it, but the others demur that this would take too long. Now it is the turn of the economist, who says with a smile, It’s simple: let’s assume we have a can opener.

This book is about the can opener. All products are like beans in a can; they need to be made accessible and drawn into the world of economic exchange. To unlock a product, a market needs to be built. The market is the can opener that delivers beans, bread, cars, shoe repair, phone service, electricity and government bonds. Each market is different and has its own quirks, glitches and miracles. But just as making a can opener is different from using it once we have one, making markets is poles apart from using them once they are up and running.

More than two decades ago, the largest attempt in history to build markets began in the postcommunist world. Both of us grew up under communist rule and experienced firsthand the abysmal ways of an overcentralized economy, and we looked on with great interest as the transition from a socialist to a market economy took shape. A slew of highly paid advisers, mostly economists, came to explain to befuddled local policymakers how to run a market. One of us sat on a Fulbright panel that sent scores of somewhat less highly paid experts to teach basic economics in fledgling business schools in East and Central Europe. These U.S. economists were on a mission to proselytize about the marvels of the market. They were explaining to hungry locals how to prepare and consume the beans once the cans were open. That the cans were sealed soon became obvious, but there was a deep conviction that cooking and eating right would somehow open the cans. They did not. Worse yet, knowledge of food preparation and consumption said little about how to make can openers.

This book is about how markets become possible, and it follows the construction of a particular market in the financial service industry: the market for payment cards. Credit and debit cards are all too familiar to everyone in the developed world. They were novelty items in the postcommunist world in 1990, after the fall of the Berlin Wall, and remained rare for many years. By the second decade of this millennium, however, they are quite common in the eight countries we researched, although the careers of plastic money took many twists and turns and resulted in markets that vary among these countries. We observed these processes in three Central European (the Czech Republic, Hungary and Poland), three East European (Bulgaria, Russia and Ukraine) and two Asian (China and Vietnam) postcommunist countries, travelling to each one multiple times, interviewing the main players and gathering corporate documents, industry publications, and secondary literature over several years. Our research was sponsored primarily by a multiyear grant from the U.S. National Science Foundation (#SES-0242076) and smaller grants from Hungary and the Czech Republic, the University of California, Boston University and Lewis and Clark College.

Just as can openers fade into the background once the cans are opened and the cooking has started, the multiyear process of research and writing that results in a book becomes invisible once the manuscript is completed, enters the publisher’s production process, and begins its new life in public. Researching and writing a book is a social process; it is embedded in personal relationships. Writing a book that presents two decades of recent history in eight countries is impossible without a lot of help. Acknowledgments allow readers a small peek into this generative process by giving credit to the many people who, although they do not appear as authors on the cover, contributed to the book in some important way. Of course any mistakes or shortcomings that remain are ours and ours alone.

In China we were aided by Tamara Perkins, whose knowledge of Chinese culture, language skills, connections and research were indispensable in the early phase of our enterprise. In Bulgaria we had the good fortune to enlist Kristina Karagyozova, then a doctoral student writing a dissertation on Bulgarian banking at the Central European University, in Budapest. A native of Bulgaria, Kristina returned to Sofia to work for the Central Bank. In Russia, Olga Kuzina of Higher School of Economics in Moscow, an utmost expert on the financial literacy of Russians, wholeheartedly threw herself into the project, mobilizing her own networks to access potential interviewees and conducting several of the interviews herself. Early in the project, Olga introduced both of us to Dilyara Ibragimova, another Russian sociologist with expertise in financial behavior, who provided us with useful consumer survey data. Tamara, Kristina and Olga wrote excellent detailed reports on their respective countries that greatly aided our writing of the comparative chapters.

We greatly benefited from the friendship of Iván Major who joined us at several interviews. His research on information economics aided us in developing ideas on information sharing. We would have been lost in Vietnam if not for Tuan Minh Pham. Tuan, a professor at Hanoi University of Technology and owner of a model management agency and a software academy, wrote the first report on the Vietnamese card market for McKinsey Consulting as a fresh MBA from New York University. He not only speaks impeccable English but is fluent also in Hungarian, and he is part of a group of experts trained in Hungary. One of the surprises of our project was that we were occasionally able to conduct interviews in Hanoi and Ho Chi Minh City in Hungarian. It was our colleague Ewa Gucwa-Leśny who introduced us to Polish banks. Ewa’s work in behavioral economics stimulated many discussions about lending. In the Czech Republic, Lubomír Lízal, director of the Economics Institute of the Center for Economic Research and Graduate Education (CERGE), lent us support and helped us better understand banking in his country.

Special thanks are due to Tom Layman of Global Visions, one of the foremost authorities on credit cards and former chief economist at Visa International; and Zsuzsanna Haraszti, one of the great card pioneers in Hungary. We are indebted to Jens Beckert, who gave us many comments over the years and whose theoretical work served as one inspiration for us. He also graciously hosted Rona-Tas several times at the Max Planck Institute in Cologne, one of the best places to think about economic sociology. We are also grateful to Joel Sobel, who spent much more time than he ever wanted putting some of our vague ideas on information sharing through the rigorous and clarifying exercise of game-theoretic modeling. It is entirely our fault and not his that this book does not provide an elegant formal model of why rational banks have difficulty sharing information in concentrated markets.

Numerous people in each of the countries helped us make the most of our research stay by facilitating our access to key informants, inviting us to give talks or helping us with accommodations. The list is long: in Russia, Pavel Ivanov, Vladimir Shavanichev, Valery Shipilov, Pavel Stromsky and Valery Torkhov; in Ukraine, Oleh Kaptar, Olga Torubara, Nelya Uss and Marina Yarovaya; in the Czech Republic, Roman Horvath and Milan Zátka; in Poland, Marcin Grodzicki and Marek Brejnak; in Bulgaria, Tanya Chavdarova, Boriana Dimitrova, Georgi Dimitrov and Roumen Avramov; in Hungary, Éva Keszy-Harmath, Júlia Király, Beáta Májer, Mária Móra and Tamás Tóth, in China, Julius Song, Li Tie, Darwin Tu and Tiger Zhou; and in Vietnam, Nguyen Quang A and Greig Craft. We must thank UC, San Diego and Boston University graduate students Atanas Grozdev, Kevin Moseby, Yoshitaka Nagai, Lisa Nunn, David Pinzur and Martha Poon for their excellent research assistance, and Rebecca Farber for preparing the index. We also got valuable help from Alex Sowerby and Stuart Clayton of the Central Europe, Middle East and Africa (CEMEA) Department of Visa International, from Euromonitor International, from David Evans of PYMNTS.com, and from the Institute of Finance and Banking of the Chinese Academy of Social Sciences.

We are fortunate to have received encouragement and intellectual sustenance from many colleagues, including Michel Anteby, Nina Bandelj, László Bruszt, Bruce Carruthers, Emilio Castilla, Paul DiMaggio, Roberto Fernandez, Jeff Haydu, Michael Hechter, Stefanie Hiss, Balázs Krémer, Imre Kondor, Mihály Laki, Martha Lampland, György Lengyel, Mark Machina, Ronald Mann, Gerry McDermott, Ashley Mears, Victor Nee, Victor Pérez-Díaz, Katharina Pistor, Woody Powell, Vadim Radaev, James Rauch, Marc Schneiberg, Richard Swedberg, Balázs Vedres, Valery Yakubovich, Ezra Zuckerman and two anonymous reviewers of the manuscript.

There are also three colleagues whose extraordinary patience with us deserves special mention: Stefanie Hiss, who works with Rona-Tas on a related but separate project; Sandrine Blanchemanche, his partner in an entirely different research endeavor; and Dilyara Ibragimova, who has teamed up with Guseva on yet another collaboration. They had to suffer numerous delays because our obsessive focus on finishing this book, especially in its later stages, temporarily pushed our other lines of research aside.

Many friends also took interest in our project and were willing to discuss ideas or share their experiences, including Zsófia Bán, Alina Bilyk, József Böröcz, Bogdan and Marina Budnik, Mariann Csáky, János Darvas, Andrea Deák, Ágnes Deák, Juan Diez Medrano, Rachel Falik, György Geréby, Vladimir Gusyev, Róza Hodosán, András Bálint Kovács, Masha and Matt Kuntz, László Márton, Ferenc Moksony, Katalin Orbán, András Róna-Tas, Ágnes Róna-Tas, Julia Sirotina, Kata Steinberger, Anna Szemere, István Szent-Iványi, Éva Veres and Gergely Zimányi. We thank Sandy Dijkstra for advice on the title and the cover.

The book owes everything to a team of professionals at Stanford, including our production editor, Mariana Raykov, and our copy editor, Alice Morrow Rowan. Our special heartfelt thanks go to our sponsoring editor at Stanford, Margo Beth Fleming, whose trust in our project, forbearance and gentle coaxing and cajoling along the way finally brought it to completion. Thank you, Margo, for bearing with us for that long.

Last but not least, we want to thank our families for their unwavering support of the project, which spanned a decade, and for providing much needed distraction along the way. It is to them that this book is dedicated.

List of Acronyms

ONE

Paying with Cards

Enter a store in the United States. Any store. You will find logos on the products sold in the store. Some logos will be familiar and others will not. The brands will be appropriate to the store: you will find a Nike swoosh in a shoe store but not in a bookshop, and the Kellogg tiger will beckon to you in a grocery but not in a hardware store. There are, however, two logos that will show up in all of these outlets. One will be a four-letter word written in blue italics on a white background, the first letter sporting an orange splash: VISA. The other will feature a Venn diagram of two overlapping circles—one fire-truck red, the other mustard yellow—across which is written, as you might have guessed by now, a compound word with an uppercase C in the middle: MasterCard.

Now go to a foreign country. Any country. You will find the same two logos almost everywhere, from Shanghai to St. Petersburg, Sofia, Szczecin, and Székesfehérvár. The further you stray from the beaten path of globalization, the fewer of these two logos you will encounter, but you will be surprised to find them occasionally even in small, rural villages in the poorest regions of the world. Though far from everyone in countries like Hungary or Ukraine will use those two logos, almost everyone will recognize them.

Today, Visa and MasterCard, together with smaller brands such as Diners Club, American Express and Discover, stand with Coke, McDonald’s, Microsoft and others as universally recognized brands. Credit cards are the epitome and a protagonist of globalization. As a new form of payment, they embody the effortless and instantaneous flow of money, in the form of information, from anywhere to anywhere else in the world. Cards tear down national boundaries by allowing travelers to pay easily, without the burden of having to carry wads of cash and to exchange one kind of currency for another. Today, traveling without a credit card turns simple transactions such as plane and hotel reservations into unduly cumbersome chores. Cards also make long-distance purchases possible. Without cards, the Internet, the most global of institutions, would never have been able to turn into a global retail marketplace. The global nature of commerce demanded a global payment system, and the large credit card companies built their own worldwide web of authorization and processing, linking souvenir shops and banks all over the world.

It is not just Western cardholders whose convenience is served by the way the credit card weaves the world into a global bazaar. Lives in the rest of the world are also profoundly affected. Globalization expands the reach of credit card markets to the less affluent parts of the world, to places where those markets had not existed earlier—in the process transforming local populations into card-carrying consumers. In this book, we trace the course of this transformation and the paths that emerging card markets carved in Bulgaria, China, the Czech Republic, Hungary, Poland, Russia, Ukraine and Vietnam. Our story is not, however, a straightforward account of globalization. We demonstrate that despite the overwhelming similarities around the world in the appearance of credit cards (small rectangular pieces of plastic proportioned according to the golden ratio,¹ with a magnetic stripe on the back exactly 0.223 inches from the upper edge, and sometimes a small embedded computer chip), and despite the undeniable ambitions of multinational card companies to present cards as a standard, McDonaldized product, postcommunist card markets neither developed according to a single Western blueprint nor proceeded in identical postcommunist ways in all of the eight countries.

Credit Card’s Dual Role: Both Payment Mechanism and Instrument of Credit

The credit card stands at the intersection of two momentous changes in the world economy. As a means of payment, the card is replacing cash as well as checks (where they previously existed) with a piece of plastic and the digital flow of information. The most recent step in a long historical progression from beads and shells to gold coins and paper money, the payment card makes the link between value and its material vessel even more attenuated.² At the same time, the credit card is also an instrument of accessing consumer credit. As such, it allows people to use money they do not yet have to buy goods now and pay for them later, and it is a major force in the rapid expansion of consumer credit and consumer culture. Thus, to understand credit card markets, we must recognize that the credit card is not one but a combination of two products: the payment card and the consumer loan.

As a means of payment, the credit card helps displace cash from day-to-day expenditures, making payments more convenient, transparent and traceable. As an instrument of credit, the card provides access to small-scale renewable loans, enabling cardholders to enjoy purchases they would not otherwise be able to afford. Historically, the two products were seamlessly fused into one in the form of a piece of plastic that fueled the twentieth-century credit card revolution in the United States. Conceptually, they are different, however. Credit can exist without cards: in the United States, retail credit has been around for much longer than cards, and examples abound of economies where installment purchases, home mortgages and personal loans flourish but no cards exist, with payments being made exclusively in cash or by check. Cards can also exist without credit: when a debit card is used, the money is immediately deducted from one’s bank account, and the issuers of pre-paid cards do not extend any credit to cardholders; the card serves only as an instrument of payment. In fact, as we show, the majority of the Visas and MasterCards in circulation in transitional countries are debit cards, so cards extend little or no credit to customers in these countries.

Each of the two products that the credit card represents—a personal loan and a payment tool—offers its own set of puzzles. For instance, as a means of payment issued to individual holders and used in a variety of retail locations, the credit card has to be peddled simultaneously to consumers and merchants, giving rise to the chicken-and-egg problem (or as we call it, the two-sided market problem). As an instrument of borrowing, the credit card necessitates solving another problem: the card issuers’ uncertainty regarding the future repayment of the loan.

Market Creation Versus Market Operation: Generative and Functional Rules

Today in the developed world, the payment card is a natural part of everyday life. We take it for granted. It works effortlessly, quickly, conveniently and innocuously. It can fulfill its functions precisely because it appears ordinary, reasonable and almost inevitable. When we pull out this piece of plastic, we know what to expect. When a cashier or waiter takes our card, they know what comes next. When a bank gives us a card, it can be fairly certain what we will do with it. Things can go wrong, such as when a card is declined at the point of sale, or stolen and used fraudulently, running up a huge tab in several countries within days. But we expect these mishaps to be the exception and develop routines to deal with them.

To appear natural, markets such as the ones that allow us to pay using plastic cards instead of coins or banknotes must have an explanation that captures the way the market works. For instance, if we ask people why they use payment cards instead of cash or checks, we may be told that it is a more convenient way to purchase things. This explanation makes sense, but it would be the right one only under several conditions. Paying with cards should not be much more costly than using cash, and card use should be secure enough to defend the cardholder from fraud. Another condition is that the electronic record of card transactions may not be used against the card-holder later, say, by the tax authorities. Still another condition is that there must be enough shops where the card is accepted so that it is worthwhile to carry the card around. And the list goes on.

Generating the conditions under which this simple explanation makes sense is what we refer to as market creation. Creating a market means constructing circumstances that allow people to conduct business by voluntarily following rational functional rules.³ We call the principles that describe market creation generative rules. The discipline of economics is interested in the rational, functional rules that drive the behavior of market actors. These rules reproduce markets, but they only work within the margins set by generative rules. Economists focus particularly on one set of powerful functional rules: those based on self-interested competition that is driven by price signals and rational calculation. As economists move away from generalized notions of the market and toward particular markets, they build more complex functional models to capture the specific features of those markets.

Reproducing a market is not the same as creating it anew, just as building roads follows a different logic than driving on them. The first logic involves the tricks of moving earth, laying concrete, mixing asphalt, painting center lines and surface markings, cutting troughs for rumble strips and gluing down Botts’ dots. The second logic involves the rules of traffic and some basic knowledge of how to operate vehicles. Once the road is built, the generative rules fade into existing circumstances and the functional rules take over. The road will still need maintenance—the filling of potholes, the repainting of markings—but we would not be able to drive from San Diego to Boston if we had to consider each and every engineering feat, past or present, that made our journey possible. This is why getting a driver’s license does not include a test on road construction.

Traditional economics dispenses with this distinction between generative and functional rules, in two ways. First, it assumes that the circumstances that serve as preconditions of markets are so general and universal that they do not merit separate study. Any surface can serve as a highway: a rocky mountainside, a sandy beach and a snow-covered tundra can all be driven on; drivers just need to make some minor adjustments. Whether one is driving on rock, sand or snow, there is traction, albeit to varying degrees. The fact that people are rational optimizers who act independently on the best information available under some very general constraints, such as scarcity of resources and available technology, will be sufficient to account for the existence of any market. Constraints, like slippery roads, will be accommodated.

Second, economists may acknowledge that conditions can vary considerably, and some necessary conditions may be absent or certain adverse conditions may be present, but they posit that evolutionary forces will propel circumstances to align with rational functional rules.⁴ The traffic will create its own pathway and will maintain it. Its needs will force the existence of proper roads. If this is true, we can always explain road design by understanding the needs of traffic. We can account for the final characteristics of the road by keeping in mind that the engineers wanted the traffic to flow properly. It is not just that we can provide an explanation ex post, but we can also confidently predict ex ante that the right circumstances will materialize. If markets work by people competitively reacting to price signals, then markets will emerge as people competitively respond to shifting price signals.⁵ In the first instance, generative rules are irrelevant; in the second, they can simply be deduced from functional rules.⁶

In the road example, the separation between generative and functional rules is clear. Road construction and driving are two different activities, done by different people with different credentials, at different times. In markets, this distinction is more blurred. The same actors who lay the foundations of the card market—card-issuing banks and credit card companies—are the ones who drive in that market (together with merchants and cardholders). The building of markets and the operating of markets are harder to separate, and markets are often constructed on the go. If markets create the conditions of their own operation, which amounts to building roads by driving, there is no need for outside intervention. Deregulation, the removal of outside interference, is the most we can do. As we show in this book, card markets do not spring up simply as a result of banks issuing cards to consumers; instead they require a lot of concerted market-building effort on the part of banks and the state, as well as multinational corporations and institutions.

There are stable markets in which the conditions are, at least for a time, relatively settled. To understand what happens in these markets, the researcher can fall back on functional rules. One can often create a rational model, beginning with laying out the market’s assumptions, inevitably followed by making some additional ones along the way, and proceeding to produce an explanation of high logical consistency. The rationalization of a market serves multiple purposes. It provides a simplified model of how it works and sometimes even allows for limited prediction. It advises actors how to behave, and makes the market legitimate by demonstrating that it functions in a reasonable and optimal manner given the circumstances. Moreover, a rational theory itself contributes to the stability of a market by providing a common language and understanding of how things ought to work. Because of their emphasis on analytic clarity and consistency, rational theories are often quite effective in coordinating people from different cultures and cognitive worlds. By justifying markets, rational theories also protect them from destabilizing moral or political criticism. But markets are rarely as frozen as economic theories portray them. When conditions shift or entirely new markets emerge, the researcher needs to look for generative rules. Besides, entrepreneurs who engage in innovation must also consider generative rules because entrepreneurship often revamps old markets or gives birth to new ones, setting up new conditions and requiring new assumptions.

Our distinction between market creation and operation, between generative and functional rules, is not new at all. This contrast is recognized by both economists and sociologists. The incongruity of generative rules and functional rules will appear to economists as market failure. One of the key functional rules of the market is that the price signal drives supply and demand. One way economists understand market failure is that the price fails to include all important existing information about the product or service. Externalities are the costs and benefits that price does not capture.⁷ An example of possible market failure is food safety.⁸ Restaurants that cook under unsanitary conditions may save money by doing so and thus outcompete clean restaurants on cost, but only if they do not have to pay for the discomfort and sickness of their customers. Yet unclean cooking not only damages the cook’s reputation but also dampens people’s overall enthusiasm for eating out and thus harms all other restaurants. For this market to work properly, food safety regulations and inspections must be in place; these conditions, which are not generated by the rules of price-guided, self-interested competition, may make the market flourish once they are installed. Then a story of rational market competition, assuming working food safety regulations and inspections, can be constructed. As long as the food safety problem is solved, these functional rules can have predictive power.

Sociologists are even more aware than economists that generative rules are not necessarily those that can describe the operation of a rational market. One of the central ideas of economic sociology is that markets are embedded—that they depend on a series of social arrangements unacknowledged by economists.⁹ This idea can be recast as the realization that the conditions of rational economic action are generated by a different set of logics. When we argue that economic transactions are embedded in social ties or institutions or cultural understandings, we essentially argue that the circumstances that make economies function are generated outside the transaction, that functional and generative rules are different. For instance, the classic example of Orthodox Jewish diamond traders in New York observes that the selling and buying of expensive gems require trust among the traders.¹⁰ This condition, however, is not produced by the functional logic of the transaction that strives for maximum profit and thus abets opportunistic behavior. The trust is generated by a separate logic, that of the religious community with its power of socialization and sanctions. Yet once the puzzle of trust is solved—thanks to religion—a rational story of supply and demand, profit maximization, and so forth can arise.

All economic sociologists agree that the market is socially constructed,¹¹ but when they go about demonstrating how markets depend on their social context, they often engage in an interpretative exercise to show how different elements of an already existing rational market are linked to the social world. This linkage is then offered as evidence that the social world does something to markets that allows them to operate: Orthodox Judaism makes the diamond trade possible, or health inspections are necessary for a restaurant business to exist. Skeptical economists, however, may point out that the causation may run in the opposite direction. It is not, they may say, that trust makes the diamond trade possible but that the trade gives people a strong incentive to be trustworthy. Religion is just an incidental form that trust takes. Precious stones are traded by people other than Orthodox Jews and even by people with no religion whatsoever. By the same token, they could argue that health regulation in the restaurant industry is unnecessary as long as eateries can be sanctioned after the fact to deter unclean cooking. Proper standards of hygiene can and will be achieved one way or another. The social conditions of the market are produced by the overriding logic of supply, demand, price and rationality.

We contend that these questions can be answered only if we take a historical, comparative approach, to see how things have unfolded in time, what came first and what came later, and to observe various ways in which markets have emerged or failed to do so.

Social Order

Markets are a particular way of coordinating economic exchange. Building a market means building this particular form of coordination.¹² There are alternative ways of organizing economic exchange, including centralized redistribution, a form of which was the centrally planned economy under communism, and reciprocity, the kind often found within families or close-knit communities.¹³ A market is characterized by the competition of self-interested, rational actors guided by price signals. Generating the preconditions of a market makes it possible for self-interested, rational actors to profit through price competition.¹⁴

Coordination of economic exchange is crucial. Coordination stabilizes expectations; without it, we cannot guess what others in the market may do and therefore cannot know what we should do. Coordination—market or any other type—lifts us from an unmanageable state of uncertainty, gives us a sense of familiarity and normalcy and allows us to act strategically. As a supplier in a market, we need to know what to expect, to predict how other suppliers and customers will react when we set out to make the product, when we deliver it, when we lower or raise prices, when we change our product, and so on. A restaurant needs to know if it will be able to get the ingredients for its cooking, whether customers will come and like the food, how much it should charge for a meal, and with which other restaurants it competes. The expectations may turn out to be wrong: ingredients may be unavailable, the cook may be a disaster, customers may not come, and so on. The important thing is not that expectations prove to be correct but that one feels able to have reasonable expectations.

The first step in creating a market is to have a cast of characters. In some markets, the barriers to entry are low and the eligibility requirements are minimal. Anyone can set up a lemonade stand on the street, but not a restaurant or a diamond business. The latter two