Virtual Economics

March 12th, 2007

Recently saw this post on Boing Boing about virtual economics. Cory Doctorow’s take on the inflation endemic to these games:

I think that this has profound implications for in-game democracy — democracy requires that you play together for a long time, in order to establish civil society. But inflation is such a fixture in virtual worlds that they are necessarily short-lived — only by beating inflation can games sustain themselves.

Cory is right, I think: dealing with these things is an essential step for the kind of virtual world that Second Life wants to create. I suspect that World of Warcraft (where the main focus) is not really the economic parts of the world) doesn’t need to worry so much.

The simplest economic theory for inflation is the quantity theory of money. In simple terms, we can say that:

M . V = P . Q

where M is the total money supply, and V is the velocity of money (how quickly money changes hands), P is the price level and Q is the number of ‘things’ in the economy. So what causes inflation (that is, changes in P)?

Change in P = Change in M + Change in V – Change in Q

(Strictly that’s in log change terms, but just think of it as percentage changes)

So the simplest version of inflation is that it happens when growth in the money supply outpaces growth in output in the virtual economy.

How do virtual worlds generally try to control things? Well, there are some significant problems to do with growth in the money supply, because there are lots of in-game tasks that create money. In Second Life, for instance, many players get a weekly allowance from the system, all of which is new money. Most of the systems involve ‘sinks’ that remove money from the game, which are adjusted to try and keep the system in balance.

But what would we call this system if it happened in real life? Well, the government of the system is printing money to finance welfare payments. Inflation isn’t really a surprise.

Can we use this real life analogy to inform the system design? How could they get inflation under control?

First, the government could run a balanced budget. The taxation in these systems is pretty implicit, making it explicit would allow a proper government budget to be produced. Then welfare payments could be balanced against income. I suspect that the system most games use is actually pretty close to this, but the democracy element that Cory suggests would really require that this power be taken out of the ‘god’ of the system and placed in the hands of some explicit government within the system.

Secondly, an independent monetary authority or central bank could play a part. Real world countries rely on monetary policy to control inflation, through setting a price on money. It’s not as clear to me that this could work in a virtual setting. In particular, in the absence of a functioning credit market it’s hard to see how the normal monetary transition channels could work.

(Setting up a banking or credit system in a virtual economy wouldn’t be that hard. The tricky part is distinguishing it from a Ponzi scheme).

All of this is just a long way to say that so long as the key government functions, such as welfare, taxation and control of the money supply, are in the hands of the ‘god’ of the system, then democracy in virtual worlds is probably going to have a hard time getting started. What’s needed is a virtual world that hands over more of the control of these types of levers to the players through the form of some kind of government.

So in actual fact, the elements that Cory suggest need to be solved to create a virtual democracy are actually some of the things that might help such a virtual democracy grow.

But until then, Second Life and its friends look to just be a bunch of hype to me.