‘Whatever Is, Is Right’? Economic Institutions in Pre-Industrial Europe

Approaches to Economic History 1. Natural Environment & Available Technology 2. Institutions ‘the rules of the game in a society... the humanly devised constraints that shape human interaction’ – Douglass North

Institutions and Efficiency Institutions as efficient solutions to economic problems Applied to: –Serfdom –Village Commune –Craft Guild –Merchant Guild

Attractions of Efficiency Models 1. Consistent with economic reasoning 2. Don’t depend on other disciplines 3. Explain how apparently inefficient institutions survive (they’re not really inefficient)

Challenges to Efficiency Models 1. Alternative explanations 2. Multiple activities (and effects) 3. Evasion and its costs 4. Wider institutional frameworks 5. Cultural beliefs and values

Alternative Explanations 1. Efficiency 2. Accident + path-dependency 3. Cultural beliefs & values 4. Conflicts over distribution

‘Efficiency’ View People experiment to minimize transaction costs (Ronald Coase) Darwinian selection ensures that only efficient institutions survive (Armen Alchian)

‘Accidental’ View Institutions are political, disproportionately influenced by small groups & individuals Individual lives are influenced by random factors Institutions are changed by random factors, perpetuated by path-dependence

‘Cultural’ View Different cultures have different beliefs & values Beliefs & values motivate people to follow institutional rules Institutions are caused by cultural beliefs & values (=> ‘cultural efficiency’)

‘Conflict’ View Institutions affect distribution as well as efficiency People disagree about distribution Distributional conflicts affect which institutions emerge

Why No Political Coase Theorem Why not agree on efficient institution, then bargain over distribution? 1. Don’t know which institution efficient 2. Disagree about maximand 3. Powerful can’t credibly commit not to use power in own interest

Distribution and Persistence Economic institutions => Distribution of resources => Distribution of political power => Future economic institutions

Pre-Modern Institutions and Conflict Serfdom Village Communities Craft Guilds Merchant Guilds

Further Challenges for Economic Theories of Institutions 1. Do institutions just do one thing? 2. Is evading institutions costless? 3. Role of institutional framework? 4. Role of cultural beliefs & values?

Do Institutions Just Do One Thing? Institutions engage in multiple activities Most institutional activities affect efficiency Efficient & inefficient activities often inseparable

Is Evading Institutions Costless? Some inefficient institutional rules are evaded But evasion imposes costs ‘Informal sector’ in modern LDCs –high risks –poor contract enforcement –‘informality’ stifles development

Role of Institutional Framework? Institutions don’t exist in isolation, but are part of wider framework Difficulty of transferring institutions between societies ‘Interlinkages’ between institutions can prevent change

Role of Cultural Beliefs & Values? ‘Pure efficiency’ models: - beliefs & values are irrelevant ‘Cultural efficiency’ models: - The ‘right’ beliefs & values => the ‘right’ institutions => economic success - The ‘wrong’ beliefs & values => the ‘wrong’ institutions => poor economic outcomes

Problems with ‘Cultural Efficiency’ Models beliefs and values hard to observe & measure no widely accepted explanation for them cultures typically combine ‘good’ & ‘bad’ depend on rules & power

Can We Explain Economic Institutions? Alexander Pope, Essay on Man, Epistle 1 (1732) All Nature is but Art, unknown to thee; All Chance, Direction, which thou canst not see; All Discord, Harmony, not understood; All partial Evil, universal Good: And spite of Pride, in erring Reason’s spite, One truth is clear, ‘Whatever is, is right.’