What Problem Were They Solving?

August 6, 2022
“What problem were these institutions solving?” has always been a central question of the “good-old New Institutional Economics,” according to Richard Langlois, in an underrated paper. Yet, that’s not the only, nor the most important question, of the NIE.
Inspired by reflections on (and some criticisms of) Doug Allen’s excellent The Institutional Revolution, Langlois seeks to “connect the two strands” of New Institutionalism. The “two strands” are the “which problem?” question and the “economic growth” question.
Langlois’ contribution is to situate these inquiries in a context of change and institutional evolution. He writes:
“The right question is not only “what problem were they solving?” but also “how did that problem emerge and how did it, and its institutional solution, change over time?” At some level, a theory of institutional change is a theory of economic growth. Both are about the process of discovering and seizing $5 bills. This is not to say, of course, that all rent-seeking, or all institutional change, is productive. In explaining the great divergence, after all, one has to explain not only why Western Europe was successful but also why so many other places were not and indeed still are not successful (North 1990).”
As examples, his paper examines the European enclosure movement and the putting-out production system (analyzed by Allen). Greif’s work on Medieval traders is also illustrative of Langlois’ approach. Even though Langlois does not put as much weight on “enforcement costs” as does Allen, he acknowledges their importance, writing:
As example might be Greif’s (2002) account of the evolution of institutions governing contract enforcement in long-distance trade. In the High Middle Ages, as we saw, the extent of the market for long-distance trade was restricted by high transportation and transaction costs. One of the main sources of transaction costs was the absence of effective institutions of contract enforcement. As a result, trade often took place within ethnic networks (Landa 1994). As transportation costs declined in the later Middle Ages and commercial city states began to thrive in places like Italy and the low countries, trade became increasingly the province of merchants who, although members of a local merchant guild, were anonymous on the larger European stage. How could these merchants expect their long-distance trading partners to honors their contracts? Greif’s answer is that a new mechanism of enforcement emerged, the Community Responsibility System. If Giovanni from Genoa reneges on his promise to Ambrose in Amsterdam, the Dutch cannot easily find the culprit let alone sanction him appropriately. But the relevant merchant guild of Amsterdam could boycott all trade with Genoa. Punishing the innocent along with the guilty (Miceli and Segerson 2007) creates an incentive for the Genoese themselves to find Giovanni and sanction him…
Notice, however, that here too growth in the extent of the market was a crucial part of the explanation of how institutions changed. It was growth in the extent of the market that increased the transaction costs that made unworkable smaller-scale enforcement systems like ethnic networks…
Shifts in preferences and political parameters did not figure heavily in our two main cases. But there is no reason in principle why such effects cannot be as important in economic history as they are in examples nearer to the present day.
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Langlois concludes with this soft critique of McCloskey:
McCloskey (2010) raises the objection that, although a theory of institutional change can explain transformations like enclosure and the factory system that enhanced productivity and raised income per capita, it cannot explain what McCloskey rightly sees the central explanandum of economic history and one of the most remarkable facts of human history – the absolutely spectacular quantitative rise in real incomes per capita, of at least a factor of 30 (and probably more if corrected properly for changes in quality as well as quantity of goods and services consumed), over the last two centuries or so in the West. I interpret this objection in the following way. It may well be possible that some institutional change – perhaps secure property rights and relative economic freedom (North 1981); perhaps the institutions of post-Enlightenment science and inquiry (Mokyr 2002); perhaps a change in attitudes towards commerce and the bourgeoisie (McCloskey 2010); perhaps something else – once in place enabled rapid change in the economic variables of growth without the underlying institution itself continuing to change. Incomes went up, but property rights didn’t get more secure and science or commerce didn’t get more fashionable. This may well be true at the level of macro institutions. But what underlay that remarkable rise in incomes was surely a continual process of seizing $5 bills at some level. Within the framework of these larger institutional structures, the process of institutional change continued at various meso and micro levels as entrepreneurs discovered new organizational and forms and new institutional systems.
In the final analysis, our thinking out to link the two classic questions of the NIE.
The rare methodology paper where you actually feel as if you’re learning economics. Highly recommended—I assign it my seminar on organizational economics.