Ryan Murphy reminds me of why I need to read Deidre McCloskey’s Bourgeois Dignity,

Institutions cannot be viewed merely as incentive-providing constraints.

— “Why Neo-Institutionalism Can’t Explain the Modern World: A Pamplet”

As of late, I’m becoming a huge fan of Douglass North’s work on institutions. If you haven’t already, I recommend his Understanding the Process of Economic Change. It’s not his most in-depth work, but it’s a good summary of his research, and if you like it you can get into his other stuff from there. He also has plenty of articles you may find online. One of the most interesting things about North is that he takes the concept of transaction costs — costs to using the pricing process — to explain the reason we have institutions at all, and this has really informed my view on market failure, what determines the distribution of income, et cetera.

But, McCloskey adds, I guess one could say, a “human touch.” As noted, I have yet to read the book, but as I understand it, McCloskey’s intention is to argue that economists shouldn’t divorce institutions from humanity, since it’s humanity which gives these institutions meaning. It’s actually a very Hayekian point. It reminds me of Hayek’s “The Meaning of Competition.” If you assume institutional constraints as given, or divorced from society, then you miss out on the process of institutional formation. It’s the day-to-day interaction between agents which creates the process of institutional change, based largely on how social norms change based on our experiences. Hayek made the same point with regards to competition, contra the model of perfect competition which assumes away the process. The same could be said of Mises’ theory of economic calculation, which Hayek later expanded upon in his work on knowledge. You can’t divorce price from the day-to-day bidding process.

McCloskey’s book (and the prequel, The Bourgeois Virtues) has been sitting on my shelf for almost a year. It’s been my loss, and it’s a big loss. It’s one of my “must reads” for the summer, where I don’t have any excuses.

Timothy Carney’s Atlantic column, “The Case Against Cronies,” has been making the rounds on the internet. He questions whether the mantra of profit maximization is really what libertarians want to advocate, knowing that profit maximization is not necessarily synonymous with social coordination. I think he misses some of the nuance in the theories of libertarians who have typically defended profit seeking behavior — no libertarian thinks we should monopolize every industry, despite the fact that a firm would maximize profit if it could garner monopoly rights. Also, libertarian economists, especially James Buchanan, have focused on the negative consequences of rent-seeking. But Carney’s main point is a good one nonetheless. I made a similar point in my review of Joseph Stiglitz’ The Price of Inequality, noting that rent seeking is an important dilemma, because it leads to non-market distributions of wealth (i.e. distributions not loosely bounded by productivity).

Before making my main point, I want to reiterate that not all rent-seeking is inefficient (from a social welfare perspective). Firms respond to regulation. Regulation can lead to sub-optimal outcomes. Rent-seeking that aims to reverse these interventions can be a positive social force. In fact, this kind of rent-seeking has been a major historical force for social change. It was the businessmen who “lobbied” the English crown in the 17th and 18th century that gave some impetus to the political movement towards pluralistic governance. They oftentimes managed to break the monopoly rights that the crown would offer certain industries. Nowadays, this is probably not so relevant, but the point remains that some rent-seeking is constructive.

But, as Carney and others point out, there is a lot of rent-seeking that is socially destructive. Carney approaches the issue from an ethical perspective. He makes the case that libertarians should criticize favored firms more vigorously and frequently. I don’t disagree with him. Public criticism goes a long way in restricting the scope of corporate choice. Bad public relations can cost a company much more money than what’s gained through rent-seeking. This is why automobile manufacturers are typically quick to recall malfunctioning product, especially in countries where consumers can quickly access information. This is also why firms don’t always opt to produce in countries where the production costs are lowest — being caught in these types of actions can lead to a large loss of customers.

Ethics can only take us so far, though. The best solutions to social discoordination are institutional (which ethics can, of course, inform). The problem is that for some reason we have not yet developed political institutions which are harmonious with the institution of the market, and vice versa. As it stands, political power can be used to distort markets, and wealth can be used to distort the political process. In his article “Market Non-Neutrality,” Gus DiZerega talks about some of these issues. I disagree with how he frames the problem, and his suggestion to separate these institutional spheres, but he looks at the same issue from a similar perspective. In my opinion, institutional progress isn’t measured by how well we can separate different institutional spheres — because of alleged ethical differences (I’m not sure how ethics can be different, if essentially the same people take part in all of them) —, but by how well these institutions harmonize with each other.

What this means is that there’s more to solving the problem of rent-seeking than just changes in how our ethics influence our actions (e.g. by being more proactive in calling out firms that conduct themselves anti-socially). We should also use our moral compasses to help shape the political process. And, I don’t mean just changes in the legislation. We already see how ineffective regulation can be, or even how burdensome regulation can be.  It also entails changes in the political institutions themselves. We need to develop political processes that, while they’ll suffer weaknesses and costs of their own, institutionalize socially constructive behavior. In econospeak, we need to change the “rules of the game.” In other words, we need to constrain the range of choice, to choices which we can define, just for the sake of conceptualization, as socially constructive.

Political transformations are difficult to fathom. Historically, these changes have tended to occur suddenly, and often very violently. But, we should start to think about them as gradual and peaceful transitions. Take, for example, the development of political pluralism in England (or Great Britain/United Kingdom, more generally). England suffered its fair share of violence, but much of the movement towards democracy was peaceful. There we saw a case of a long-term, gradual, and more-or-less peaceful institutional transition. As institutions improve these kinds of transitions should become more prevalent, because they will be formed with a greater degree of innate flexibility.

Why isn’t the institutional approach typically addressed (except in certain academic environments)? I think that people tend to focus on market institutions. We have a hundred years, or more, of theoretical developments that tells us that markets are often imperfect. It’s accepted that the institutions of markets need to improve. But there exists some relationship between markets and politics, so it doesn’t make sense to separate the two when we are talking about progressive changes in how market agents behave. Many of the rules of markets are set by governments, and if we want to see improvements in these rules, and how these rules are formed and enforced, we also need to see political change.

Once people familiarize themselves with the idea that it’s not just markets which are imperfect, it’s also government, I think we’ll see more flexibility in institutional progress in the sphere of governance. There will always be resistance, but our society is already relatively pluralistic. The extent to which those in power can raise obstacles to change is more limited than it was in the past. This suggests not only that these type of changes are easier, it also implies that they should occur faster. And while institutions have been seen as important facets of society for at least 250 years (since the Scottish enlightenment), it has more recently become a truly flourishing subject area in economics (and in other disciplines, as well). These scientific developments will be transferred to the general public in due time. We have already seen, for instance, how theories like public choice have influenced the public.

Nicolas Maduro’s election to the Venezuelan presidency in mid-April stirred quite a bit of controversy, mostly because of his rhetoric and the political program he represents. The man he replaced, Hugo Chávez, was known for his manipulation of Venezuelan democratic institutions and his horrendous economic policies. While Maduro has received most of the attention, his election is not the only one in Latin America that raises eyebrows. In Paraguay, Horacio Cartes was just elected president. Cartes’ record is not any better than Maduro’s (or Chavez’, for that matter), but he is a conservative so maybe there is less of an ideological incentive to question the legitimacy of the process that brought him to power. Neither do questionable politics end with Paraguay and Venezuela. The majority of Latin American countries suffer from institutional problems, including weak democracies (although, there are various governments there which are typically highly rated by democracy indexes — Chile, Uruguay, Costa Rica, Nicaragua, Panama, and Peru).

Anti-democratic politicians are oftentimes liked, and their policies can be popular. This suggests that there is a degree of disillusion with democracy. Many Latin Americans feel as if this type of governance doesn’t work for them. This doesn’t mean that autocracy is preferred, but that the pluralism of democracy isn’t pluralistic enough — it took populist leaders in countries like Venezuela and Ecuador to include the indigenous population in the process of decision making — and it isn’t bringing about results which are improving local standards of living. The recent rise of populist politics can be interpreted as a social experiment, with society there looking for alternatives to their current institutions. So far, the outcomes seem to worsen their conditions, rather than improve them.

I wonder if this will remain true in the long-run, though. Consider the process of institutional change during the late Middle Ages and throughout the Industrial Revolution. The major powers which emerged in the 14th century were great kingdoms like Spain and France. These were characterized by autocratic regimes, with top-down bureaucracies. They were also economically weak, but they managed to secure large quantities of raw materials and metal through imperialism. English institutions were not much better at this time, although one can argue that English common law was always superior to continental law. Nevertheless, England was a relatively poorer society. What propelled England to become the leading world power was a process of institutional change, where autocracy gradually gave way to greater pluralism. Whereas the continental powers were able to rest on their laurels, so to speak, the English were in a position where the incentive to adapt was relatively high.

Could the situation be similar with Latin America (and other emerging countries)? We know that there are problems with democracy. The disciplining process, compared to other institutions we know (i.e. the market), is inadequate. We know this because bad policies are often not immediately recognized as such. The costs are externalized onto others, and they are y often so dispersed that it’s difficult for somebody to recognize their true scope. This doesn’t necessarily mean that democracy must be dispensed with, only that there is ample room for improvement. Yet, we can question just how open modern stable democracies are to such improvement. There is little incentive, because few people know there is even a problem to be solved. In these countries democracy also works “well enough.” The situation seems analogous to that of France and Spain during the age of enlightened autocrats; these advanced democracies are “resting on their laurels.”

Where there is the most political experimentation are exactly those nations which are relatively worse off today. They are still looking for stable institutional outcomes, and democracy, so far, has not helped them accomplish this end. It’s true that many of these societies may end up adopting democracy after a number of preconditions have been met, such as a broader distribution of wealth. We have plenty of example of this happening: Chile, Brazil, Uruguay, et cetera. But, there must be some probability that a struggling polity will land on some institutional order that is superior to democracy, and if this occurs then there is a high probability that said polity will experience a period of relatively high economic growth. It is somewhat similar to the process by which England became a great power. Is the next great economic power in Latin America, or Asia, or Africa?

Another question is whether societies really “rise and decline.” It is true that many societies have undergone institutional transformations where the outcome is clearly worse than it was originally. Ancient Rome comes to mind (republic to autocracy), as does Athens. But, it seems to me that another route that changes in the international distribution of power can take is simply through competition. For instance, it’s not necessarily true that the Spanish Empire rose and then declined — it was always a relatively poor society —, it was simply that other countries had greater incentive to change for the better. It’s similar to competition in the market, where successful entrepreneurs settle in their advantageous position and are later out-competed by those seeking to take their place.

It’s somewhat taboo to talk about the U.S. as a country which will experience a decline in international power. A lot of people talk about the “U.S. Empire” and try to establish analogies between the U.S. and the Soviet Union (especially after the invasion of Afghanistan), and other regimes that went through similar processes. Since these theories are often naïve, the whole subject of whether the U.S. will lose its status carries with it a stigma. But, I think it’s a valid and interesting question. Who will be the future power (will there be a future power, or will international relations become more pluralistic?), and where will this power come from? I think a case can be made that if the the U.S. is displaced, the contender will come from amongst today’s “emerging markets.”

P.S. Huff has some thoughts on institutions and culture. I think we are more-or-less in agreement, although I take issue with the following sentence,

Institutions and rules are simply parts of culture, and cannot be created or tweaked independently of it.

The word “institutions” is a catch-all term that abstracts from the various things that influence them (which is why economists typically define the word “institutions” as “the rules of the game”). But, there’s more to institutions than just culture, and there’s more than just culture influencing institutions. In a modern society there will exist some pluralism in cultural values, and institutions will have to arbitrate between these, and help constrain cultural divergences that may otherwise undermine the political process. A lot of this has to do with the sharing of values between cultures — cross cultural influence —, but cultures themselves can be influenced by institutions. I had a quick thought on this a week ago or so.

Other than culture, things that influence the shaping of institutions include knowledge (much of which can be in opposition to cultural values) and industry. I suppose that we can tie culture to these, perhaps with the concept of cultural pluralism in mind, but then I’m afraid that the term “culture” becomes barren. It hides the fact that there is a rich collection of sources which decide the path institutional development takes, and it can also hide the fact that culture itself is influenced by institutional development.

This was the gist of my gripe with Caplan’s post. It’s not just expectations which change institutions, but institutions which change expectations. Society doesn’t just develop certain cultural values and then institutions will form around these values, rather institutions develop and culture can come to reflect these institutions. Nevertheless, I agree that it works the other way around, as well. P.S. Huff, for instance, writes,

It allows us to see clearly why institutions which work brilliantly in one cultural setting may collapse immediately into chaos if implanted in harsher soil.

I agree. When we talk about institutions it’s a two way street, with a society’s values influencing the viability of certain institutions, but institutions also forcing changes in the culture. In an aforementioned post I used the term Althusserian interpellation, which at the extreme stands contrary to agency theory (our environment influences us versus we influence our environment). The truth is probably somewhere in between, and it most likely fluctuates — it’s dynamic.