I’ll start my blog by a summary of a brilliant article published in an excellent review. For almost two decades now, economic historians have been toying with the concept of institutions. Everything has been said about it, and more often than not it led nowhere. This article is not revolutionary nor does it open a brand new field or create a new debate. On the contrary, this article ends a debate – for a while at least; and that is every bit as important.
OGILVIE Sheilagh (2007) “‘Whatever is, is right’? Economic institutions in pre-industrial Europe”, Economic Histroy Review, 60/4, 649-684.
Introduction: De gustibus non est disputantum
Before the introduction of the concept of institutions, economic history was chiefly concerned with the natural endowment of a given region and the technological advancement of a given time. Anything else was considered to depends on preferences which were deemed stable, exogenous and not really worth debating (649). But gradually man-made rules (be it political or social) appeared to be too important to be ignored. These ‘humanely devised constraints’ became the new craze in economic history (650).
The question of the causes of institutions soon arose. An optimist point of view became the consensus: a society has specific problems (e.g. market failures) and need devices (a.k.a institutions) to overcome them. Thus institutions are thought to have a positive impact and to arise to solve efficiently specific issues (651). Arguably, there can be a black sheep or two but institutions that stood the test of time are to be considered efficient (652).
Hence many pre-modern institutions have been considered to have had a n overall positive impact on the economy and society as solutions to existing problems. The merchants’ guilds, the medieval village commune (653), the corporations and even serfdom have all been reconsidered as costs-minimizing systems allowing to coordinate the actors, increase security, boost productivity or impede cheating (654). In this article, the author denies that all long-lasting institutions were necessarily efficient and try to understand how the economic rationality can explain that inefficient institutions may have lasted for centuries.
Concept and misconceptions
As institutions are costly to set up, it is likely that people would not invest in those perceived as inefficient. Historians see two possibilities for what happens next: whether the least efficient ones disappear in a Darwinian process, or some become inefficient but their inner strength allow them to survive (path dependency theory) (656).
Ogilvie remarks that all too often economic historians have a foggy interpretation of the word ‘efficiency’. She distinguishes three common uses of the word in the literature: (1) rationality (agents do whatever is best for themselves), (2) Pareto efficiency (no one can be better off without someone being worth off), and (3) rightfulness (optimal distribution of resources or any other moral view) (658).
The three (possible) causes of the institutions
The accidental view: institutions can be caused by random exogenous elements (legal origins, technological improvement, natural endowment). It can only be grasped by empirical inquiry and never through a model.
The cultural approach: The exogenous view assumes that values and beliefs (‘subjective models’, D. North) come from outside of the economic system and determine its shape (e.g. Max Weber on protestantism and capitalism). The endogenous view considers that a society’s values originate from the inside of the economic system along side the institutions (659).
An extreme version of the endogenous approach sees the institutions as nothing else than a set of shared beliefs which is self-sustaining as all the any actor’s behaviour is based on the assumption that the others will behave following similar guidelines (game theory) (661).
Institutions as conflicts: the basic principle is that institutions are not efficient in any way and that they affect both the “size of the total economic pie and who gets how big a slice”.
Because people have various interests and preferences (one may favour leisure, the other profit, and another religious observance), they disagree on which institution would be best. Institutions are the result of this struggle (662). The author insists that this approach is the best because it takes into account both costs and benefits of every institution instead of focusing solely on the positive aspects. The long life of certain inefficient institutions is thus explained by the ability of their beneficiaries to impose it upon society (663).
“Efficient outcomes are possible only if all affected parties can negotiate their way […] to a binding agreement. But binding agreements pre-suppose an enforcing party with a monopoly of physical violence. [This third party] will be under constant temptation to use that capacity to cheat, rob, or oppress others […] leading to suboptimal outcomes.” (664)
Thus efficiency affects distribution and distribution, in turns, affects efficiency (665).
The multivariate approach
For the author, conflicts, stochastic shocks, path dependency and cultural factors ought all to be considered as potential causes for each institution studied (667). She points out three characteristics of the institutions that should not to be forgotten by researchers:
(1) Any institution does many things, they have a wide variety of activities, with a wide variety of effects. In general, to be able to fulfill one role, an institution has to do other things, which may turn out to be costly (668). For instance, guilds may have been designed to enforce quality, but they were also used to create monopolies (670).
(2) As any law creates a crime, institutions – here defined as a set of rules – necessarily created an informal sector in its shadow (671). By preventing some transactions and making evasion costly and dangerous, institutions cause potentially important deadweight losses (672). This explains why outsiders often want to join in.
(3) An institution is rarely alone, it usually is located in a self-sustaining framework. This interlocking explains the solidity of some inefficient institutions; each institution is submitted to the inertia of the whole system (674).
(4) Taking into account the interplay between culture and institution. Culture almost singlehandedly can explain why – with similar endowment – two societies can develop radically different institutions. But it is not to say that economic well-being is caused by a ‘good’ set of values. Besides, it may be next to impossible to use empirically the concept of culture – how do you observe 1000 years old mental models (677)? Besides, the same set of values can have different outcomes: the whole of Europe has a patriarchal model but the condition of women vary greatly from a place to another (678).
Still culture remains essential to the understanding of the causes of the wealth of nations: “if achieving better economic outcomes just requires better rules, then any culture can do it” (679).