With the exception of Vicky Pryce, few economists will ever step foot in prison. Most will never study crime and punishment in any form. Instead, the vast amount of research on the topic is conducted by sociologists and criminologists. That is a shame, however, because the economist’s toolkit is perfectly suited to understanding nearly every aspect of the goings on within a prison. And life in prison teaches important economic lessons, too. In particular, life behind bars has much to show economists about how people respond to incentives and the general problem of how to sustain social cooperation.

The very nature of prison is rules. Inmates are prohibited in their movements, in what they can own, and with whom they can interact. There is a long tradition in political economy studying how rules work, what differs between formal and informal rules, where rules come from, and what makes for a good rule. Indeed, Adam Smith studied such things. A major challenge in this tradition is in determining how to devise rules that lead to good outcomes, even when the people governed by those rules are less than angelic.

Inmates want to feel safe from other inmates; they want their property protected; and they want assurances that dealings with other inmates will be carried out. Sometimes prison guards provide governance, but very often this is not the case. One problem facing inmates is that they tend to have less self control, less education, come from poorer backgrounds and broken families, and are less trustworthy than the typical person in society. Despite these limitations, my work on prison life in California shows that they are actually able to sustain a high level of cooperation. Consider two different situations.

Firstly, when prison populations are small, inmates know each other well. Fear of being deemed an outcast amongst a tightly-knit group of convicts encourages people to be nicer to each other. When inmates want drugs or alcohol, they can only turn to inmate entrepreneurs. Somebody who takes advantage of another inmate in such an exchange will be ostracised or assaulted. Fear of becoming an outlaw among outlaws incentivises good conduct. As a result, the underground economy flourishes.

However, when prison populations get too big, it becomes difficult to keep track of other inmates’ social standing. Decentralised rules fail. It is too hard to know who amongst the thieves and killers will be trustworthy and who should be shunned. As such, ostracism is not a feasible punishment device, and the fear of being an outcast no longer provides a sufficiently strong check on bad behaviour.

In such situations in  California  a major source of order has emerged from among a group of people that we typically assume are a primary cause of disorder—prison gangs. Prison gangs wield violence to govern the social and economic affairs of inmate life. They develop written constitutions. They have informal courts to adjudicate disputes between inmates. Their extensive recordkeeping allows them to keep track of disruptive inmates far more carefully than in a decentralised system. When the prison yard is peaceful, gangs make substantial profits selling drugs, so they have an incentive to control chaotic acts of violence. Stability and peace are the key to profits.

There are two lessons here. Even amongst the least trustworthy people in society, prison life shows us that order can emerge in a spontaneous way, and that this process can sometimes achieve very high levels of social and economic cooperation. Secondly, the larger the grouping, the more important are more formal rules. This is something that we also see, for example, in financial markets. It is amazing how far these observations generalise to other areas of economics.

David Skarbek is Senior Lecturer in Political Economy at King’s College London and author of the award-winning book, ‘The Social Order of the Underworld: How Prison Gangs Govern the American Penal System’. This article was first published in EA Magazine.