First thoughts on institutions and development 

For many decades, researchers have been asking why some countries are so rich and some so poor. They have offered many answers, from corruption to banking to guns, germs, and steel. A widely if vaguely held view is that “institutions” are central. In seminal work on this theme, Nobelist Douglass North defined institutions as “the rules of the game in a society, or, more formally, … the humanly devised constraints that shape human interaction.” In their recent book, Why Nations Fail, Daron Acemoglu and James Robinson popularize earlier scholarship with Simon Johnson on the historical roots of key institutions that undergird private enterprise, such as rule of law and secure property rights.

My curiosities tend in these directions. Now that I’m freelancing, I’m hoping to carve out time to explore such ideas on my own.

At the moment, I’m particularly interested in the thinking of North, John Wallis, and Barry Weingast, as presented in their book, Violence and Social Orders. It’s not an easy read. If I understand right, a turning point in economic history, in their view, was the creation of open-access economic systems. In the first half of the 19th century in industrializing countries, a much larger class of people gained the right to form corporations: perpetually lived legal entities that transcended their creators. These corporations could make contracts just like people. They were subject to impersonal laws, meaning ones that applied the same to all legal persons, granting no privileges to individuals such as nobility. No longer was the approval of the King or Parliament, say, required to charter a new corporation. Crudely speaking, “anyone” could now start a formal legal entity, a corporation.

Of course, as with voting rights, “anyone” began as a narrow category—it helped to be a white, male, property owner—and expanded over time. Regardless, the nature of economic development changed fundamentally, becoming much more complex and dynamic. As I see it, if organisms are the means by which genes play the game of life—experimenting and reproducing, competing and cooperating—then corporations are the analogous means by which people play the game of economics. Lowering the barriers to entry into the economic game widened the scope for experimentation. In short order, economic diversity exploded. Scientific breakthroughs, new products, new techniques for management, manufacturing, and marketing…all arrived in an accelerating cascade.

A fascinating question probed by North, Wallis, and Weingast is why access was opened. Openness to new players eroded the monopoly profits (rents) of existing players, which were the currency and glue of the economic order. Why did the elites see it as in their interest to allow competition from new players, and in such an uncontrolled way? Why did they want to move from basing economic rights on identity (e.g., whether you were someone who had obtained through connections a government-granted import monopoly for tea, or had inherited domain over a territory thanks to your ancestors’ provision of military service to a king) to one offering enforcement of economic rights to a broad class of people? The answer seems to lie in the desire of powerful people to restrain each other in order to reduce risk in their commercial dealings with each other. I’d rather be exempt from the rule of law, free to buy and sell and steal and kill as I please. But I want no else to be so exempt. Historically, many societies settled into equilibria where some people, notably kings and queens, obtained such privilege. But somehow as industrialization gathered steam, such equilibria became less stable. People with economic and political power grew more supportive of the disinterested application of laws to enforce property rights and contracts, even at the cost of some discretion for themselves.

This is worth emphasizing: in opening the economic system, the people with power acted out of short-term, individual interest. As if by chance, they produced an economic revolution.

North, Wallis, and Weingast say a lot more about why and how this happened. I need to read and think more before I can distill their work while doing it justice. You might peruse their associated working paper.

Perhaps because of my background in theoretical math, I’m curious about how to abstract from this historical analysis using game theory, in order to elucidate its essence. Three theoretical ideas seem to emerge. I’m not sure how they fit together. Out of self-interest, the dominant players of the economic game choose:

  • …to create a special player called government, which has the power to enforce rules. This power increases the penalty for defecting from agreements and violating property rights, which increases cooperation among players and reduces one source of uncertainty about the future, making investment safer. Of course, the government is still accountable to the elites, so its rules and enforcement thereof are uneven. Perhaps the core idea is that players under a certain set of rules cooperate to change the rules: a self-modifying game.
  • …to fling the door open to new players. This increases diversity and accelerates economic evolution.
  • …to create a new economic game, a level up in complexity. As in the transition from single-cell creatures to multicellular ones, the players in this new game are combinations of players in the old one, i.e., corporations. And as in that transition, the hierarchical separation between old and new games—between economic interactions between people and economic interactions between corporations—is slimy, not clean. The game between corporations emerges incrementally, organically from the game between people. Arguably, they are the same game. But they are as qualitatively different as a farmer’s market and a shopping mall, cluster of moneylenders at a bazaar and a modern banking system.

To me, now, this feels like it gets pretty deep into why economic development has happened. But while this intellectual search could lead to practical lessons, I don’t mean to suggest that it will produce the golden key of development, the one bit of advice that will make poor nations rich. Meaning no presumption, I see the attempt to understand the political economy of the elaboration of the economic game as analogous to Adam Smith’s elucidation of the functioning of markets. We can wonder at the power of spontaneous markets and observe that they seem central to economic development. That does not answer the grand questions of why markets have developed, where they have overdeveloped, and how, as a practical matter, they should be further developed. Just telling people to have markets doesn’t get you very far.

Still, an understanding the virtues and limits of markets should inform policy. Likewise, an understanding of how the economic game becomes more dynamic and open should have practical relevance.

No doubt lots of people have thought and written along these lines. If writers come to mind, I hope you’ll recommend them to me. Soon, I intend to summarize Robert Axelrod’s Evolution of Cooperation, one more small step on my journey.