Diamonds are Forever

“We are perishing for want of wonder, not for want of wonders,”

~ G.K. Chesterton 

Forged miles beneath the earth’s crust. 

Eternal—or as close as we get in this vale of tears. 

Objects of endless fascination and avarice, the diamond is at times witness to bloody conflict in its production and exchange (more on that below). 

Diamonds have proven irresistible to the scholar’s pen (admittedly, a low bar) and the professor’s lecture (admittedly, a lower bar).

They’re also my answer to a friend’s question recently posed to me.

“Suppose you had to teach a semester-long class,” he began. 

“So far, so good,” I’m thinking. 

“Using examples from only one object.” 

“That’s a lot harder,” I chew on the problem. 

“What would it be?” he asks. 

It wasn’t but a moment before I hit on my answer. 

A typical semester includes about fourteen weeks of instruction. 

How much economics could I teach, using only diamonds for illustration? Pretty far, I think, and far enough. 

Here’s a quick whirlwind tour—fourteen topics, fourteen weeks.

I’d have to teach the class to flesh out the details, but this is a start. 

Value

Where else to begin but the diamond-water paradox? 

This famed intellectual puzzle is not just the premier diamond-using economics example. It also elucidates what’s at the core of contemporary economic theory: subjective marginalism. 

The paradox ponders: Why are diamonds—a frippery—more expensive than water—necessary to sustain human life? 

Some version of this question flummoxed Aristotle, Plato, Aquinas, Copernicus, Locke, Benjamin Franklin, Adam Smith, and a host of other luminaries. 

The solution came by way of a watershed intellectual event called the Marginal Revolution. 

Disarmingly simple, the puzzle’s key resides in the fact that humans don’t value entire classes of items. Instead, they always choose between “a little more of this” and “a little less of that.”

Since water, in most contexts, is so much more plentiful than diamonds, a little more water is much less valuable than a little more diamonds. We can access water for free—open your mouth when it’s raining. We have so much water that we “waste” it in frivolous activities like water-balloon fights or in stunts like the once-popular ALS ice-bucket challenge. Most people in most places would satisfy a relatively unimportant goal with an additional gallon of water. 

Change the context, change the results. Someone dying of thirst in the desert will sign their life away for a glass of water. An entire cup—even a bucket—of diamonds? They’ll pay pennies, or nothing at all.

Were one confronted with the fantastical and unenviable choice of eliminating either all the water or all the diamonds from earth in a reverse genie situation, a non-sociopathic chooser would clearly banish diamonds. 

Likewise, if tomorrow we discovered a diamond waterfall hidden in the Amazon rainforest—an endless stream of diamonds—their price would plummet. Diamonds would be like water is now. You’d go to your favorite restaurant and ask for a cup of diamonds, which your host would oblige without blinking an eye. 

In fact, scientists estimate that there are over a quadrillion tons of diamonds buried deep beneath the earth’s surface. Perhaps one day diamonds will serve as children’s baubles—and little else. 

Cost and Price 

Diamond mines are expensive. 

The heavy machinery used to excavate diamonds likewise comes with a hefty price tag. 

Unsurprisingly, diamonds themselves can be jaw-droppingly pricey. The Pink Star diamond, mined in 1999, and about half the size of a strawberry, sold at a 2017 auction for $71 million. And that was 2017—so $71 million meant something.

This all raises the question of whether there is a causal relationship between the price of diamond inputs (mines, equipment, labor, etc…) and diamonds themselves. And if so, which direction does the causation run? 

Classical, pre-Marginal Revolution economists suggested that high input prices were somehow transmitted to the price of consumer goods—at least in the long run. 

Yet, this view mires us in insuperable circularities. For instance, how to explain the price of bread? The Classical economists appealed to the price of labor inputs (wages) necessary to produce bread. But what explains those labor input prices? Well…the prices of all the stuff that sustains workers, including…bread. 

Suffice it to say that the Marginal Revolution corrected this mistaken perspective on causality. A brief thought experiment may be clarifying. Suppose that international demand for diamonds collapses—perhaps because of mass conversions to a religion that condemns diamonds as excessively showy.

If diamond mines were exclusively capable of producing diamonds, if mines had no other use, such widespread conversions would cause mines to lose all their value. Simple once you see it, the Marginal Revolution showed that value—and prices—flow from final consumer goods like diamonds back to input prices like mines, not the other way around.

Botuobinskaya, a Russian mine opened in 2015, is expected to yield about 1.5 million carats of diamonds annually for forty years. While I can’t find the mine on Zillow, one would expect a hefty price tag to accompany this plot of barren, desolate earth. People love their diamonds, which is why they’re willing to pay a lot to own them. Accordingly, mines capable of yielding large quantities of high-quality diamonds are outrageously expensive. 

Yet, not every input in the diamond production process commands jaw-dropping compensation. Lapidary—gem cutter—wages are not particularly high. And like all prices, wages are set by the interaction of supply and demand. While the demand for diamonds is substantial, the supply of lapidaries is also large relative to that demand. The job simply doesn’t require the skills of a professional athlete or a CEO. If only a handful of people could become lapidaries, we’d expect higher wages for them, all else equal. Here we see the insights of the Marginal Revolution again, this time applied to labor markets. 

Such basic, supply and demand reasoning should inform our thinking about wages in every market. For instance, teachers aren’t paid much. That’s because many people can become teachers. They’re the water of the Diamond-Water Paradox; NFL quarterbacks are the diamonds. 

Imagine a world where teachers are billionaires. The implication would be that the skills required for teaching are extremely rare, only a few people each generation possessing the requisite capabilities. 

In such a world, teachers would be well-paid, but children would be illiterate. 

The Division of Labor

It’s obvious that the distribution of the world’s resources is vastly unequal. 

What’s sometimes overlooked is that this fact confronts mankind before trade, or any other human activity, alters the distribution and ownership of resources. 

Inequality is built into the structure of reality. 

A four-letter word in the lexicon of some, inequality of resource distribution is one of the important drivers of the division of labor at national, regional, and individual levels. And without the division of labor, humans would be condemned to live isolated, impoverished lives. Imagine trying to produce everything you wish to consume without making a single trade. 

The world’s stunning resource diversity contributes to the law of comparative costs (i.e. “comparative advantage”) because such regional diversity gives rise to different opportunity costs associated with producing various goods and services. 

While there is one tiny, active (and open to the public) diamond mine in the United States (in Murfreesboro, Arkansas), it’s relatively costly for the United States to produce diamonds. They’re sparse, buried deeply, and of lower quality than can be found in other locales. It’s therefore unsurprising that the United States produces hardly any diamonds. 

The top five diamond-producing countries—Russia, Botswana, the Congo, Australia, and Canada—boast large, high-quality diamond deposits, relatively close to the earth’s surface. Botswana, roughly the size of Texas, is home to seven of the world’s best diamond mines.

Americans could outlaw the purchase of any foreign diamonds. Buy American (diamonds)! 

As a result, we would mine deeper, dig harder, and pay more for our jewelry. The unseen cost would come from all the labor and machinery inefficiency diverted to diamond production, at the expense of other things we’re better at producing. We’d be wealthier to rely on international trade for the bulk of our diamonds.

There’s another aspect of the division of labor that’s relevant here too, and it occurs at the individual, rather than the national level. Adam Smith famously observed that “the division of labor is limited by the extent of the market.” It only makes sense to specialize in that for which a sufficiently large market exists. 

Most people treat diamonds as luxury items. We thus wouldn’t expect to see them produced and traded in primitive societies. When basic wants are still unsatisfied, no one would find it profitable to specialize in the production and sale of diamonds. While primitive tribesmen might trade items such as seashells for jewelry, we wouldn’t find them opening mines or going to school (there wouldn’t be “schools”) to become gem cutters. 

The extent of the market is an upper bound on specialization.

Elasticity 

You might think that cash-strapped governments could easily balance their budgets by taxing expensive items like diamonds. If you’re a progressive, you might even see an added benefit of soaking the rich, while avoiding taxes on the poor. Diamonds seemingly present themselves as an attractive source of funds to squeeze. 

Yet, this notion is flawed. 

In 1991, the Bush administration implemented a luxury tax on items like yachts and jewelry with the explicit aim of reducing the federal deficit. The tax lasted only two years before the Clinton administration repealed what had been an utter failure from the perspective of those implementing the tax.

The rich have innumerable options for spending their money. It’s easy for them to “escape” from taxed items. When the luxury tax increased the price of yachts and jewelry, the rich fled these assets and put their money elsewhere (real estate, stocks, etc…). The demand for yachts/diamonds is highly elastic—sensitive to price changes—as opposed to (say) the demand for cigarettes. 

The demand for the taxed luxury items was so elastic that the tax worsened the government’s budgetary position. In fact, the drop-off in yacht sales was so steep that the industry contracted severely and many ship-building construction workers lost their jobs. The government paid out more in unemployment benefits than it collected in taxes. 

The deficit grew larger. 

Middlemen

Individual jewelry consumers don’t buy directly from the De Beers Group. 

Instead, they go to a local jeweler—a middleman. 

In fact, in advanced, industrial economies, buying from middlemen is the rule, not the exception. Most people don’t buy their food directly from farmers or their clothing directly from textile manufacturers. Most students don’t rent the hourly services of scholars to teach them. Instead, they attend a university staffed with experts who have studied work generated (largely) by others. 

Market economies are shot through with middlemen. Many people argue that these entities are parasites, leeches on otherwise valuable exchanges. At my first job, I recall one lunch hour during which I was harangued by a co-worker who insisted that banks and insurance companies are nothing more than exploitative “money movers.” My friendly colleague is not alone; Thomas Sowell documents that people have directed intense animus at middlemen across the globe and throughout history. 

However, it’s probably not an exaggeration to say that, without middlemen, life would be “nasty, brutish, and short” to borrow Thomas Hobbes’ felicitous expression. Middlemen specialize in uniting those who would like to buy and those who would like to sell. Stock brokerages or other financial intermediaries like banks—the organizations my lunch partner railed against—are the classic examples. 

Without middlemen, there’d be no such thing as credit markets, to take one example. The return to saving would be lower. Without as much saving, there’d be less capital goods accumulation and thus less output of consumer goods. The world would be vastly poorer. 

But middlemen do more than that. They also specialize in discerning the quality, genuineness, attributes, and safety of products. What’s more, they put their own reputation on the line to do so. This saves buyers the costs of search, knowledge acquisition, inspection, and the like. 

In performing this role, middlemen reduce the individual number of reputations that a consumer must keep track of to make successful purchases. While there are hundreds of producers extracting valuable stones and while there are thousands of persons cutting and polishing them, a consumer need only know what sort of quality and product variety to expect from (say) Kay’s Jewelers. Buyers know that Kay’s will sell certain types and qualities of jewelry and that Walgreens won’t carry medicines that are poisonous at recommended doses. 

Depending on time, it might also make sense for us to touch on vertical integration in this section of my hypothetical course. Clearly, some companies specialize in diamond extraction, others in polishing and cutting, and still others in retail sales to consumers. The reasons for vertical disintegration in this instance are not particularly clear to me, but each of these topics is a week in class, so there’d be plenty of time to ponder.

Time Preference 

Diamonds are forever. 

(Technically, diamonds aren’t indestructible. Nuclear blasts and hammers alike would render them liquid or dust, respectively—I asked a materials science guy).

But most of the time, diamonds are here to stay, which means their services also stretch into perpetuity. In this regard, diamonds resemble a plot of land—its services aren’t “used up” over time. They’re like the burning bush of biblical fame. 

The fact that both land and diamonds exchange for finite prices is proof that humans place a premium on the present or, to say the same thing, that they discount the future. 

Land yields an infinite stream of services (barring something like nuclear cataclysm); diamonds yield an infinite stream of satisfaction. If they didn’t discount the future, humans would be willing to pay an infinite amount for an infinite stream of something valuable. Yet, we never see exchanges occurring at infinity prices. 

Humans’ discount of the future is why goods with services which aren’t consumed in use still sell for finite prices. 

Cartel and Monopoly 

Besides the Diamond-Water Paradox, diamonds probably come up most frequently in economics courses to illustrate issues pertaining to cartels and monopoly. 

For a good chunk of the 20th century, the De Beers Group (1888-present), a cartel, held the leasing rights for most of the world’s known diamond mines. Along with the Alcoa bauxite mines, the De Beers case is one of the only examples of (essentially) one seller controlling the global supply of a natural resource. As most mines were in South Africa, keeping track of the world’s supply of diamonds was initially a manageable task. 

De Beers also convinced most of the rest of the world’s diamond miners to sell through its Central Selling Organization (CSO). The CSO inspected and sold these diamonds to downstream dealers—see more on this unusual process below.

To my mind, the De Beers’ cartel raises three important issues. It would be tough to squeeze them all into a single week, but I suppose more opportunities to remind students of scarcity are better than fewer. 

First, Econ 101 teaches us that cartels are highly unstable arrangements. Cartel members face incentives to cheat, to “chisel,” on the cartel arrangement; external pressure derives from producers who never joined the cartel or who eventually break away. 

The persistence of the De Beers cartel is therefore somewhat of a puzzle. 

Unlocking this mystery lies in realizing that in the heyday of De Beers’ cartelization, there was no free diamond market at all. The South African government nationalized the diamond mines. De Beers would lease the mines from the government, which laid first claim to any new deposits in the country. From there, De Beers made their own production and pricing decisions, albeit in the context of a highly interventionist system. 

When new mines were discovered in the former U.S.S.R., that government cut a deal with De Beers, and the cartel went international. The South African government even patrolled the coast to prevent diamond smuggling. See Murray Rothbard’s discussion for more details. The lesson: persistent cartels require enforcement mechanisms, and government is the most common and effective enforcer. 

Secondly, many infer that De Beers’ dominance allowed it to enjoy “monopoly profits.”

My view is that the cartel did not bestow monopoly profits, but that it did result in higher diamond prices. 

De Beers, which would rent land from the government, would have paid the fully capitalized value of the land (assuming the government charged a price comparable to what a private owner would, of which there is no guarantee). Presumably, this fully capitalized price reflected the value to De Beers of having a government-backed cartel. This price is higher precisely because having a government-backed cartel allowed De Beers to sell diamonds for higher prices. 

In short, windfall gains would have gone, in one way or another, to government officials, but not to De Beers’ owners. 

The third issue concerns the prices that De Beers’ cartel status allowed them to charge. Even during the heyday of DeBeer’s dominance, its ability to charge elevated, monopoly prices for diamonds was still highly constrained by several factors. This idea also relates to my second point above in that these constraints would have influenced how much De Beers would be willing to pay to lease a mine.

Importantly, there are myriad close substitutes for diamonds. For example, alongside diamonds, the Bible mentions over twenty stones prized for their beauty. These stones were known thousands of years ago, and all existed in the relatively small geographic region (Palestine) where the Bible’s authors lived. Like the diamond, these stones were and are all used in jewelry and architecture. Today, the Gemstone Encyclopedia lists over 300 beautiful stones. Substitutes for diamonds abound.

What’s more, diamonds’ permanence severely curtails the higher price that might arise from one entity controlling all known sources of a commodity. This idea, known as the Coase Conjecture, suggests that once the durable cat is out of the bag, it becomes another source of competition. As soon as De Beers makes a sale, it creates a secondary diamond market. New diamond owners become competitors with De Beers. A single global seller of diamonds is thus analytically distinct from a single global seller of bread, a highly perishable item.

Lastly, you might have noticed the important caveat word “known” in the preceding sentences. Potential competition for De Beers stems from the fact that anyone on earth, at any moment, could discover an as-of-yet unknown diamond deposit. This happens, time-to-time, with diamonds. 

Throughout the 20th century, people discovered new diamond deposits across several continents. 

Transaction Costs

When De Beers meets with a prospective, commercial buyer, the interaction looks, well, bizarre. 

The customer tells De Beers what they’re looking for. De Beers responds by offering the would-be buyer a “sight”—a packet of diamonds De Beers representatives have selected. 

De Beers makes this offer on a “take-it-or-leave-us” basis. If the buyer is unsatisfied with the packet and decides not to buy, De Beers will never interact with that buyer again. Ever. Not exactly how exchange works at the local supermarket.

Most analyses suggest this odd arrangement reflects exploitation or nefarious market power. Given the wide-ranging secondary market for diamonds, such an explanation is uncompelling. Furthermore, this practice continues to the present-day, years after it has been meaningful to talk of a De Beers cartel.

Yoram Barzel has argued that the curious De Beers selling arrangement maximizes the value which the exchange creates—for both parties. 

It does so by reducing transaction costs. Buyers can economize on the costs associated with sorting, measuring diamond quality, negotiating on price, and the like. Saving on such transaction costs increases the price sellers receive and reduces the measuring costs buyers incur, yielding gains for both.

This curious exchange structure raises the specter of De Beers cheating potential customers by offering a diamond “sight” of low quality relative to the price being asked. But De Beers’ valuable brand name constrains them. If they developed a reputation for short-changing their customers, it wouldn’t be long before buyers would resort entirely to secondary markets or other producers, refusing interactions with De Beers. Remember, De Beers is not the only option to acquire diamonds. 

What incentive would De Beers have to repeatedly offer bad batches of diamonds? They’re in the business of making exchanges, after all. 

And due to the value of their brand name, we have reason to believe that De Beers’ commitment to quality is credible.

Commitment

At least in the United States, engagement rings are a relatively recent invention.

Before 1935, it was not customary for a man to offer a woman an engagement ring as a promise of his intention to wed. 

That all changed when Indiana became the first state to strike down the so-called “breach of promise” action. 

We might dispute the justice of such a law, but let’s focus on the economics instead. In short, the law had granted women the right to sue men for monetary damages when the latter broke off an engagement. 

For women, at the time, a broken engagement could spell disaster. Their opportunities in labor markets were highly constrained and men were hesitant to marry women who’d been promised to someone else. Marriage was therefore critical to a woman’s earthly comfort. The breach of promise law gave women confidence that a man’s offer to marry was likely a serious one—he faced a lawsuit if he developed cold feet.

With this legal rug yanked from beneath her feet, a woman sought other means to establish the credibility of a man’s promise to marry. People don’t come with their character type tattooed on their forehead. And Hobbes once observed that “nothing is more easily broken than a man’s word.” How could a woman sort the boyish chaff from the masculine wheat? 

Margaret Brinig offers a compelling answer. Diamond engagement rings filled the commitment vacuum left by the disappearing breach of promise laws. Men began offering diamond rings to women as a sort of performance bond. If a man broke his promise to wed, he would also forfeit the costly investment he’d made in a ring. In the event of a non-committal suitor, women could sell their ring into secondary jewelry markets, earning, as it were, monetary damages.

More importantly, women knew that saying yes to a man who didn’t offer a ring was risky business.

Advertising

Brinig also documents that America’s first nationwide advertising campaign began in the 1930’s at De Beers’ behest by New York advertising agency Ayers (1869-2002).

It was Ayers (in 1947) which coined the expression “diamonds are forever.” Ayers went so far as to negotiate with Hollywood producers to shoehorn betrothal scenes into movies, the most notable of which occurred between Mae West and Cary Grant in the 1933 She Done Him Wrong (adapted from a 1928 play named, coincidentally, Diamond Lil).

Like middlemen, advertising often gets a bad rap. 

John Kenneth Galbraith is famous for arguing that capitalists “create” new wants in consumers by way of advertising. Yet, in the diamond case, Ayers most certainly did not create the new diamond craze that was sweeping the United States. As Brinig shows, the diamond engagement ring took off four years before the Ayers campaign began in 1939. Ayers apparently piggybacked on the momentum created by women’s demand for a credible indication of marital commitment.

Advertising, by itself, is not sufficient to compel consumers to develop brand loyalty. As Joseph Schumpeter once remarked, “The prettiest girl that ever lived will in the long run prove powerless to maintain the sales of a bad cigarette.” 

What gets lost in the Galbraithian preference debate are all the other functions that advertising fulfills in the free enterprise system. It provides useful product information to buyers. It allows producers to engage in the sort of rivalrous jostling that ultimately delivers value to consumers. It facilitates the opportunity of one producer to expose the secrets of others, keeping them mutually honest. 

And, just like diamonds themselves, advertising fosters commitment. When consumers observed De Beers launching the first nationwide ad campaign in U.S. history, they were reassured that De Beers was in it for the long run. 

Imagine what would have happened if De Beers had attempted to cut costs by selling faux diamonds. People would have stopped buying diamonds, at least new diamonds from De Beers. As a result, De Beers would never have recouped the massive advertising investments they made. 

Advertising serves to make commitments credible.

Labor Contracts

Speaking of movies, in Diamonds are Forever, the seventh film in the James Bond juggernaut, Sean Connery was paid what was then a record-breaking sum of $1.25 million for his role as the world’s most iconic spy.

Connery’s sum looks paltry now, even adjusted for inflation. 

In 2016, Robert Downey Jr. earned a $40 million lump sum to appear in Captain America: Civil War. These enormous lump sums notwithstanding, the biggest box-office paydays often come from actors’ profit-sharing agreements with movie studios. Downey made (at least) an additional $40 million from other aspects of his contract, including profit-sharing. Connery, in Diamonds are Forever, made (roughly) an additional $4 million. 

Why are actors sometimes paid lump sums, other times by way of risky profit-sharing, and why so often a mixture of both? 

Darlene Chisholm has explored these questions in the Hollywood context. Higher effort levels from actors correlate positively with the box-office bottom line. A problem arises because actors have an incentive to shirk since work isn’t always fun—even for actors. Thus, offering a profit-sharing agreement is one way to discipline actors’ shirking. It gives them a stake in the final product. 

Why, then, do studios use any contract other than a profit-sharing agreement for actors and actresses? Hammering out the details of profit-sharing contracts is costly, and a standardized fixed-payment contract saves resources. Studios offer profit-sharing contracts only when constraining shirking is particularly valuable. 

Two quick examples illustrate some of the variables influencing this calculus. Big-name actors are more likely to receive share contracts because they have an incentive to coast on the reputation they have already established. Actors are more likely than actresses to receive share contracts. 

An instance of hypocritical, Hollywood elites discriminating against women? Hardly. 

Some 70% of leads are played by men and incentivizing the lead is of utmost importance. When a woman plays a leading role, she is also more likely to be offered a share contract. (Someone could argue that a disproportionate share of male leads is evidence of discrimination, but I’m not investigating that claim here). 

It thus makes sense that a superstar like Connery would have received a share contract, especially for playing one of the most recognizable leading roles of all time. 

To alter laborers’ incentives and thus their behavior, change the way they’re paid. 

Property Rights

Property rights, in the economic sense, describe a person’s capacity to exercise control over an asset. 

Control refers to the ability to appropriate the services an asset may render. Private property rights exist when the ability to exercise control is held by a party or parties who aren’t part of government.

For instance, a private property right gives a diamond owner the ability to display it (on the owner’s property), destroy it (see the point about hammers above), exchange it, wear it, or bury it in the owner’s backyard. 

Yet, property rights do not fall exogenously from the heavens. They require resources to establish, define, and protect against all-comers. How much owners invest in protecting their property rights derives from how highly they value the property in question. Diamonds are highly valuable assets—see their market price—which suggests that people will invest significant quantities of resources in their protection. 

Think of any heist movie. Much of the plot’s drama resides in how the would-be thieves will overcome the series of near-impossible obstacles standing between them and the object of their desire. It’s that way with diamonds too. People keep their diamonds in expensive lockboxes or behind crisscrossing lasers.

It’s instructive to contrast diamonds with another small object: pencils. How many resources do people typically expend to secure property rights to their writing utensils? Almost none. Pencil thieves, therefore, abound. Yet somehow the pencil thief problem does not rise to the level of national conversation. 

On the flip side, people never absent-mindedly leave diamonds scattered on their desks.

The bottom line is that the strength of private property rights protection is a choice variable. The value of the resources in question influence that choice.

Private Governance 

Yes, diamonds are well-protected, but they also have characteristics which make them easier to steal, characteristics that raise the costs of protecting them. 

Namely, diamonds exhibit some of the highest value-to-weight ratios of any item in the world. 

Items with this characteristic are primary targets of theft—they’re easy to conceal and therefore steal. 

Furthermore, only highly skilled individuals can distinguish fake diamonds from the genuine article. Trade in diamonds seemingly provides ample opportunity for fraud and theft. 

It’d be reasonable to expect that the diamond dealing industry always relies heavily on the state’s laws and courts to enforce contracts, punish theft, and curtail fraud.

It does not. 

In fact, the diamond industry is one of the world’s preeminent examples of private governance—privately devised rules for regulating commercial interaction. The details are documented extensively by Lisa Bernstein in a series of papers, and by Barak Richman in his book, Stateless Commerce: The Diamond Network and the Persistence of Relational Exchange. 

As Richman shows, Manhattan’s 47th Street—the world-renowned Diamond District—was a virtually government-free zone (at least with respect to diamonds) for decades. 

Rather than rely on government, the Orthodox Jews of the diamond business did commerce and adjudicated disputes through their self-created Diamond Dealers Club (DDC). The discipline of continuous dealings undergirded trade and the DDC’s communication of prior arbitration decisions informed diamond dealers about who to avoid. Richman’s book also reveals some the causes behind the unraveling of long-standing private governance in the diamond industry.

So, why, exactly, was a self-created, informal legal arrangement better for so many diamond dealers? Interestingly, Medieval merchants also forsook local government courts in favor of law they themselves created, the world-famous Lex Mercatoria. 

For both Medieval merchants and for diamond dealers, opting out of the formal legal system made sense because the state-sponsored legal system was too costly along a host of margins. Uncertainty about future judicial rulings made contract formation hard. Courts don’t always calculate damages correctly. They’re slow. They’re expensive. 

Instead, as Bernstein puts it: “Jewish diamond dealers in the New York bourse [trading center] in the early 1990s were able to exchange millions of diamonds simply by shaking hands and intoning the [Hebrew] phrase mazal u b’racha.” When disputes arose, they were handled by the Diamond Dealers Club. Yet, true crime was rare. Members of the Jewish diamond community had just about everything to lose upon expulsion from their tight-knit diamond network. 

For details on this sophisticated system of dispute resolution, ostracism, and extralegal governance, see Richman’s book. 

The Resource Curse 

Some economists have made the counterintuitive case that a nation apparently blessed with an abundance of natural resources is actually cursed. 

The so-called resource curse says that conflict over a country’s valuable resources mires it in endless rent-seeking, extortion, bribery, nationalization, and even outright violent contestation. 

While all these outcomes are possible in a world of rich natural resource endowments, the divergent paths of two of the world’s leading diamond exporters—Botswana and the Democratic Republic of the Congo—demonstrate that the resource curse is anything but deterministic. 

Over the last few decades, the landlocked Botswana has become one of Africa’s success stories. Meanwhile, the Congo remains mired in civil war and grinding poverty. GDP per capita is about ten times higher in Botswana relative to the Congo. 

The presence or absence of natural resources is never the ultimate cause of economic development. 

Underlying all other proximate causes of development are institutions, the formal and informal rules of the game that structure economic interactions. Dramatically oversimplifying, Botswana more closely approximates an ideal of secure private property rights, low taxes, liberalized trade, sound money, and the rule of law. 

The Congo is anything but. 

Within the context of the right institutional infrastructure, large diamond deposits—or any other natural resource—will not doom a country to endless infighting. Saudi Arabia and Australia are two good examples: both resource-rich, both prosperous, both free of violent, internal conflict. Counterexamples are readily available, but this only reinforces my point that institutions are the ultimate cause. 

Of course, the story of how to get and keep “good” institutions is far more complicated. Yet, the resource curse is a good jumping off point for a discussion of institutional origins, function, and evolution.

These topics don’t exhaust the economic lessons that the tiny, glorious diamond illuminates. 

A course with time to spare might explore how workers’ compensation in diamond mines influences their wages, the impact of tort law on investments in mining safety and pollution control, or the rates at which entrepreneurs deplete their mines.

But suppose someone said I couldn’t use diamonds for my illustrations. 

What then? 

I’d go with the tennis ball—but that’s a story for another day.