Inside and Outside Perspectives on Institutions: An Economic Theory of the Noble Lie

If there exist no incentive or selective mechanisms that make cooperation in large groups incentive-compatible under realistic circumstances, functional social institutions will require subjective preferences to diverge from objective payoffs – a “noble lie.” This implies the existence of irreducible and irreconcilable “inside” and “outside” perspectives on social institutions; that is, between foundationalist and functionalist approaches, both of which have a long pedigree in political economy. The conflict between the two, and the inability in practice to dispense with either, has a number of surprising implications for human organizations, including the impossibility of algorithmic governance, the necessity of discretionary rule enforcement in the breach, and the difficulty of an ethical economics of institutions.