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American Economic Association Institutions Author(s): Douglass C. North Source: The Journal of Economic Perspectives, Vol. 5, No. 1 (Winter, 1991), pp. 97-112 Published by: American Economic Association Stable URL: http://www.jstor.org/stable/1942704 . Accessed: 09/11/2014 20:29 Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at . http://www.jstor.org/page/info/about/policies/terms.jsp . JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org. . American Economic Association is collaborating with JSTOR to digitize, preserve and extend access to The Journal of Economic Perspectives. http://www.jstor.org This content downloaded from 130.126.162.126 on Sun, 9 Nov 2014 20:29:34 PM All use subject to JSTOR Terms and Conditions Journal of EconomicPerspectives- Volume5, Number1-Winter 1991-Pages 97-112 Institutions Douglass C. North Institutionsare the humanly devised constraints that structure political, economic and social interaction. They consist of both informal constraints (sanctions, taboos, customs, traditions, and codes of conduct), and formal rules (constitutions, laws, property rights). Throughout history, institutions have been devised by human beings to create order and reduce uncertainty in exchange. Together with the standard constraints of economics they define the choice set and therefore determine transaction and production costs and hence the profitability and feasibility of engaging in economic activity. They evolve incrementally, connecting the past with the present and the future; history in consequence is largely a story of institutional evolution in which the historical performance of economies can only be understood as a part of a sequential story. Institutions provide the incentive structure of an economy; as that structure evolves, it shapes the direction of economic change towards growth, stagnation, or decline. In this essay I intend to elaborate on the role of institutions in the performance of economies and illustrate my analysis from economic history. What makes it necessary to constrain human interaction with institutions? The issue can be most succinctly summarized in a game theoretic context. Wealth-maximizing individuals will usually find it worthwhile to cooperate with other players when the play is repeated, when they possess complete information about the other player's past performance, and when there are small numbers of players. But turn the game upside down. Cooperation is difficult to sustain when the game is not repeated (or there is an endgame), when information on the other players is lacking, and when there are large numbers of players. * Douglass C. North is Luce Professorof Law and Libertyand Directorof the Centerin Political Economy, WashingtonUniversity,St. Louis, Missouri. This content downloaded from 130.126.162.126 on Sun, 9 Nov 2014 20:29:34 PM All use subject to JSTOR Terms and Conditions 98 Journal of EconomicPerspectives These polar extremes reflect contrasting economic settings in real life. There are many examples of simple exchange institutions that permit low cost transacting under the former conditions. But institutions that permit low cost transacting and producing in a world of specialization and division of labor require solving the problems of human cooperation under the latter conditions. It takes resources to define and enforce exchange agreements. Even if everyone had the same objective function (like maximizing the firm's profits), transacting would take substantial resources; but in the context of individual wealth-maximizing behavior and asymmetric information about the valuable attributes of what is being exchanged (or the performance of agents), transaction costs are a critical determinant of economic performance. Institutions and the effectiveness of enforcement (together with the technology employed) determine the cost of transacting. Effective institutions raise the benefits of cooperative solutions or the costs of defection, to use game theoretic terms. In transaction cost terms, institutions reduce transaction and production costs per exchange so that the potential gains from trade are realizeable. Both political and economic institutions are essential parts of an effective institutional matrix. The major focus of the literature on institutions and transaction costs has been on institutions as efficient solutions to problems of organization in a competitive framework (Williamson, 1975; 1985). Thus market exchange, franchising, or vertical integration are conceived in this literature as efficient solutions to the complex problems confronting entrepreneurs under various competitive conditions. Valuable as this work has been, such an approach assumes away the central concern of this essay: to explain the varied performance of economies both over time and in the current world. How does an economy achieve the efficient, competitive markets assumed in the foregoing approach? The formal economic constraints or property rights are specified and enforced by political institutions, and the literature simply takes those as a given. But economic history is overwhelmingly a story of economies that failed to produce a set of economic rules of the game (with enforcement) that induce sustained economic growth. The central issue of economic history and of economic development is to account for the evolution of political and economic institutions that create an economic environment that induces increasing productivity. Institutions to Capture the Gains from Trade Many readers will be at least somewhat familiar with the idea of economic history over time as a series of staged stories. The earliest economies are thought of as local exchange within a village (or even within a simple hunting and gathering society). Gradually, trade expands beyond the village: first to the region, perhaps as a bazaar-like economy; then to longer distances, through particular caravan or shipping routes; and eventually to much of the world. At This content downloaded from 130.126.162.126 on Sun, 9 Nov 2014 20:29:34 PM All use subject to JSTOR Terms and Conditions DouglassC. North 99 each stage, the economy involves increasing specializationand division of labor and continuously more productive technology. This story of gradual evolution from local autarky to specializationand division of labor was derived from the German historical school. However, there is no implication in this paper that the real historicalevolution of economies necessarilyparalleled the sequence of stages of exchange described here.' I begin with local exchange within the village or even the simple exchange of hunting and gathering societies(in which women gathered and men hunted). Specialization in this world is rudimentary and self-sufficiencycharacterizes most individual households. Small-scale village trade exists within a "dense" social network of informal constraints that facilitates local exchange, and the costs of transactingin this context are low. (Although the basic societal costs of tribal and village organization may be high, they will not be reflected in additional costs in the process of transacting.)People have an intimate understanding of each other, and the threat of violence is a continuous force for preserving order because of its implicationsfor other members of society.2 As trade expands beyond a single village, however, the possibilities for conflict over the exchange grow. The size of the market grows and transaction costs increase sharply because the dense social network is replaced; hence, more resources must be devoted to measurement and enforcement. In the absence of a state that enforced contracts, religious precepts usually imposed standards of conduct on the players. Needless to say, their effectiveness in lowering the costs of transacting varied widely, depending on the degree to which these precepts were held to be binding. The development of long-distance trade, perhaps through caravans or lengthy ship voyages, requires a sharp break in the characteristics of an economic structure. It entails substantialspecializationin exchange by individuals whose livelihood is confined to trading and the development of trading centers, which may be temporary gathering places (as were the early fairs in Europe) or more permanent towns or cities. Some economies of scale-for example, in plantationagriculture-are characteristicof this world. Geographic specializationbegins to emerge as a major characteristicand some occupational specialization is occurring as well. The growth of long distance trade poses two distinct transaction cost problems. One is a classical problem of agency, which historicallywas met by IIn an article written many years ago (North, 1955), I pointed out that many regional economies evolved from the very beginning as export economies and built their development around the export sector. This is in comparison and in contrast to the old stage theory of history deri-,ed from the German historical school, in which the evolution was always from local autarky to gradual evolution of specialization and division of labor. It is this last pattern that is described here, even though it may not characterize the particular evolution that in fact has occurred. 2For an excellent summary of the anthropological literature dealing with trade in tribal societies, see Elizabeth Colson (1974). This content downloaded from 130.126.162.126 on Sun, 9 Nov 2014 20:29:34 PM All use subject to JSTOR Terms and Conditions 100 Journal of EconomicPerspectives use of kin in long-distance trade. That is, a sedentary merchant would send a relative with the cargo to negotiate sale and to obtain a return cargo. The costliness of measuring performance, the strength of kinship ties, and the price of "defection" all determined the outcome of such agreements. As the size and volume of trade grew, agency problems became an increasingly major dilemma.3 A second problem consisted of contract negotiation and enforcement in alien parts of the world, where there is no easily available way to achieve agreement and enforce contracts. Enforcement means not only such enforcement of agreements but also protection of the goods and services en route from pirates, brigands, and so on. The problems of enforcement en route were met by armed forces protecting the ship or caravan or by the payment of tolls or protection money to local coercive groups. Negotiation and enforcement in alien parts of the world entailed typically the development of standardized weights and measures, units of account, a medium of exchange, notaries, consuls, merchant law courts, and enclaves of foreign merchants protected by foreign princes in return for revenue. By lowering information costs and providing incentives for contract fulfillment this complex of institutions, organizations, and instruments made possible transacting and engaging in long-distance trade. A mixture of voluntary and semi-coercive bodies, or at least bodies that effectively could cause ostracism of merchants that didn't live up to agreements, enabled long-distance trade to occur.4 This expansion of the market entails more specialized producers. Economies of scale result in the beginnings of hierarchical producing organizations, with full-time workers working either in a central place or in a sequential production process. Towns and some central cities are emerging, and occupational distribution of the population now shows, in addition, a substantial increase in the proportion of the labor force engaged in manufacturing and in services, although the traditional preponderance in agriculture continues. These evolving stages also reflect a significant shift towards urbanization of the society. Such societies need effective, impersonal contract enforcement, because personal ties, voluntaristic constraints, and ostracism are no longer effective as more complex and impersonal forms of exchange emerge. It is not that these personal and social alternatives are unimportant; they are still significant even in today's interdependent world. But in the absence of effective impersonal contracting, the gains from "defection" are great enough to forestall the development of complex exchange. Two illustrations deal with the creation of a 3Jewish traders in the Mediterranean in the 11th century "solved" the agency problem as a result of close community relationships amongst themselves that lowered information costs and enabled them to act as a group to ostracize and retaliate against agents who violated their commercial code. See Avner Greif (1989). 4Philip Curtin's Cross Cultural Trade in World History (1984) summarizes a good deal of the literature, but is short on analysis and examination of the mechanisms essential to the structure of such trade. The Cambridge Economic History, Volume III (1966), has more useful details on the organization of such trade. This content downloaded from 130.126.162.126 on Sun, 9 Nov 2014 20:29:34 PM All use subject to JSTOR Terms and Conditions Institutions 101 capital market and with the interplay between institutions and the technology employed. A capital market entails security of property rights over time and will simply not evolve where political rulers can arbitrarily seize assets or radically alter their value. Establishing a credible commitment to secure property rights over time requires either a ruler who exercises forebearance and restraint in using coercive force, or the shackling of the ruler's power to prevent arbitrary seizure of assets. The first alternative was seldom successful for very long in the face of the ubiquitous fiscal crises of rulers (largely as a consequence of repeated warfare). The latter entailed a fundamental restructuring of the polity such as occurred in England as a result of the Glorious Revolution of 1688, which resulted in parliamentary supremacy over the crown.5 The technology associated with the growth of manufacturing entailed increased fixed capital in plant and equipment, uninterrupted production, a disciplined labor force, and a developed transport network; in short, it required effective factor and product markets. Undergirding such markets are secure property rights, which entail a polity and judicial system to permit low costs contracting, flexible laws permitting a wide latitude of organizational structures, and the creation of complex governance structures to limit the problems of agency in hierarchical organizations.6 In the last stage, the one we observe in modern western societies, specialization has increased, agriculture requires a small percentage of the labor force, and markets have become nationwide and worldwide. Economies of scale imply large-scale organization, not only in manufacturing but also in agriculture. Everyone lives by undertaking a specialized function and relying on the vast network of interconnected parts to provide the multitude of goods and services necessary to them. The occupational distribution of the labor force shifts gradually from dominance by manufacturing to dominance, eventually, by what are characterized as services. Society is overwhelmingly urban. In this final stage, specialization requires increasing percentages of the resources of the society to be engaged in transacting, so that the transaction sector rises to be a large percentage of gross national product. This is so because specialization in trade, finance, banking, insurance, as well as the simple coordination of economic activity, involves an increasing proportion of the labor force.7 Of necessity, therefore, highly specialized forms of transaction organizations emerge. International specialization and division of labor requires institutions and organizations to safeguard property rights across inter- 5North and Weingast (1989) provide a history and analysis of the political institutions of 17th century England leading up to the Revolution of 1688 and of the consequences for the development of the English capital market. 6see North (1981), particularly chapter 13, and Chandler (1977). Joseph Stiglitz's (1989) essay, "Markets, Market Failures, and Development," details some of the theoretical issues. 7The transaction sector (that proportion of transaction costs going through the market and therefore measureable) of the U.S. economy was 25 percent of GNP in 1870 and 45 percent of GNP in 1970 (Wallis and North, 1986). This content downloaded from 130.126.162.126 on Sun, 9 Nov 2014 20:29:34 PM All use subject to JSTOR Terms and Conditions 102 Journalof EconomicPerspectives national boundaries so that capital markets (as well as other kinds of exchange) can take place with credible commitment on the part of the players. These very schematic stages appear to merge one into another in a smooth story of evolving cooperation. But do they? Does any necessary connection move the players from less complicated to more complicated forms of exchange? At stake in this evolution is not only whether information costs and economies of scale together with the development of improved enforcement of contracts will permit and indeed encourage more complicated forms of exchange, but also whether organizations have the incentive to acquire knowledge and information that will induce them to evolve in more socially productive directions. In fact, throughout history, there is no necessary reason for this development to occur. Indeed, most of the early forms of organization that I have mentioned in these sections still exist today in parts of the world. There still exist primitive tribal societies; the Suq (bazaar economies engaged in regional trade) still flourishes in many parts of the world; and while the caravan trade has disappeared, its demise (as well as the gradual undermining of the other two forms of "primitive" exchange) has reflected external forces rather than internal evolution. In contrast, the development of European long-distance trade initiated a sequential development of more complex forms of organization. The remainder of this paper will examine first some seemingly primitive forms of exchange that failed to evolve and then the institutional evolution that occurred in early modern Europe. The concluding section of the paper will attempt to enunciate why some societies and exchange institutions evolve and others do not, and to apply that framework in the context of economic development in the western hemisphere during the 18th and 19th centuries. When Institutions Do Not Evolve In every system of exchange, economic actors have an incentive to invest their time, resources, and energy in knowledge and skills that will improve their material status. But in some primitive institutional settings, the kind of knowledge and skills that will pay off will not result in institutional evolution towards more productive economies. To illustrate this argument, I consider three primitive types of exchange-tribal society, a regional economy with bazaar trading, and the long-distance caravan trade-that are unlikely to evolve from within. As noted earlier, exchange in a tribal society relies on a dense social network. Elizabeth Colson (1974, p. 59) describes the network this way: The communities in which all these people live were governed by a delicate balance of power, always endangered and never to be taken for This content downloaded from 130.126.162.126 on Sun, 9 Nov 2014 20:29:34 PM All use subject to JSTOR Terms and Conditions DouglassC. North 103 granted: each person was constantly involved in securing his own position in situations where he had to show his good intentions. Usages and customs appear to be flexible and fluid given that judgement on whether or not someone has done rightly varies from case to case... . But this is because it is the individual who is being judged and not the crime. Under these conditions, a flouting of generally accepted standards is tantamount to a claim to illegitimate power and becomes part of the evidence against one. The implication of Colson's analysis as well as that of Richard Posner in his account of primitive institutions (1980) is that deviance and innovation are viewed as threats to group survival. A second form of exchange that has existed for thousands of years, and still exists today in North Africa and the Middle East is that of the Suq, where widespread and relatively impersonal exchange and relatively high costs of transacting exist.8 The basic characteristics are a multiplicity of small-scale enterprises with as much as 40 to 50 percent of the town's labor force engaged in this exchange process; low fixed costs in terms of rent and machinery; a very finely drawn division of labor; an enormous number of small transactions, each more or less independent of the next; face to face contacts; and goods and services that are not homogeneous. There are no institutions devoted to assembling and distributing market information; that is, no price quotations, production reports, employment agencies, consumer guides, and so on. Systems of weights and measures are intricate and incompletely standardized. Exchange skills are very elaborately developed, and are the primary determinant of who prospers in the bazaar and who does not. Haggling over terms with respect to any aspect or condition of exchange is pervasive, strenuous, and unremitting. Buying and selling are virtually undifferentiated, essentially a single activity; trading involves a continual search for specific partners, not the mere offers of goods to the general public. Regulation of disputes involves testimony by reliable witnesses to factual matters, not the weighting of competing, juridical principles. Governmental controls over marketplace activity are marginal, decentralized, and mostly rhetorical. To summarize, the central features of the Suq are (1) high measurement costs; (2) continuous effort at clientization (the development of repeat-exchange relationships with other partners, however imperfect); and (3) intensive bargaining at every margin. In essence, the name of the game is to raise the costs of transacting to the other party to exchange. One makes money by having better information than one's adversary. 8There is an extensive literature on the Suq. A sophisticated analysis (on which I have relied) focused on the Suq in Sefrou, Morocco is contained in Geertz, Geertz, and Rosen (1979). This content downloaded from 130.126.162.126 on Sun, 9 Nov 2014 20:29:34 PM All use subject to JSTOR Terms and Conditions 104 Journalof EconomicPerspectives It is easy to understand why innovation would be seen to threaten survival in a tribal society but harder to understand why these "inefficient" forms of bargaining would continue in the Suq. One would anticipate, in the societies with which we are familiar, that voluntary organizations would evolve to insure against the hazards and uncertainties of such information asymmetries. But that is precisely the issue. What is missing in the Suq are the fundamental underpinnings of institutions that would make such voluntary organizations viable and profitable. These include an effective legal structure and court system to enforce contracts which in turn depend on the development of political institutions that will create such a framework. In their absence there is no incentive to alter the system. The third form of exchange, caravan trade, illustrates the informal constraints that made trade possible in a world where protection was essential and no organized state existed. Clifford Geertz (1979, p. 137) provides a description of the caravan trades in Morocco at the turn of the century: In the narrow sense, a zettata (from the Berber TAZETTAT, 'a small piece of cloth') is a passage toll, a sum paid to a local power... for protection when crossing localities where he is such a power. But in fact it is, or more properly was, rather more than a mere payment. It was part of a whole complex of moral rituals, customs with the force of law and the weight of sanctity-centering around the guest-host, client-patron, petitioner-petiof which are tioned, exile-protector, suppliant-divinity relations-all somehow of a package in rural Morocco. Entering the tribal world physically, the outreaching trader (or at least his agents) had also to enter it culturally. Despite the vast variety of particular forms through which they manifest themselves, the characteristics of protection in the Berber societies of the High and Middle Atlas are clear and constant. Protection is personal, unqualified, explicit, and conceived of as the dressing of one man in the reputation of another. The reputation may be political, moral, spiritual, or even idiosyncratic, or, often enough, all four at once. But the essential transaction is that a man who counts 'stands up and says' (quam wa qal, as the classical tag has it) to those to whom he counts: 'this man is mine; harm him and you insult me; insult me and you will answer for it.' Benediction (the famous baraka), hospitality, sanctuary, and safe passage are alike in this: they rest on the perhaps somewhat paradoxical notion that though personal identity is radically individual in both its roots and its expressions, it is not incapable of being stamped onto the self of someone else. While tribal chieftains found it profitable to protect merchant caravans they had neither the military muscle nor the political structure to extend, develop, and enforce more permanent property rights. This content downloaded from 130.126.162.126 on Sun, 9 Nov 2014 20:29:34 PM All use subject to JSTOR Terms and Conditions Institutions 105 Institutional Evolution in Early Modern Europe In contrast to many primitive systems of exchange, long distance trade in early modern Europe from the 11th to the 16th centuries was a story of sequentially more complex organization that eventually led to the rise of the western world. Let me first briefly describe the innovations and then explore some of their underlying sources.9 Innovations that lowered transaction costs consisted of organizational changes, instruments, and specific techniques and enforcement characteristics that lowered the costs of engaging in exchange over long distances. These innovations occurred at three cost margins:(1) those that increased the mobility of capital, (2) those that lowered informationcosts, and (3) those that spread risk. Obviously,the categories are overlapping, but they provide a useful way to distinguish cost-reducing features of transacting.All of these innovations had their origins in earlier times; most of them were borrowed from medieval Italian city states or Islam or Byzantiumand then elaborated upon. Among the innovations that enhanced the mobility of capital were the techniques and methods evolved to evade usury laws. The variety of ingenious ways by which interest was disguised in loan contracts ranged from "penalties for late payment,"to exchange rate manipulation(Lopez and Raymond, 1955, p. 163), to the early form of the mortgage; but all increased the costs of contracting. The costliness of usury laws was not only that they made the writing of contracts to disguise interests complex and cumbersome, but also that enforceabilityof such contractsbecame more problematic.As the demand for capital increased and evasion became more general, usury laws gradually broke down and rates of interest were permitted. In consequence, the costs of writing contracts and the costs of enforcing them declined. A second innovation that improved the mobilityof capital, and the one that has received the most attention, was the evolution of the bill of exchange (a dated order to pay, say 120 days after issuance, conventionally drawn by a seller against a purchaser of goods delivered) and particularlythe development of techniques and instrumentsthat allowed for its negotiabilityas well as for the development of discounting methods. Negotiability and discounting in turn depended on the creation of institutions that would permit their use and the development of centers where such events could occur: first in fairs, such as the Champagne fairs that played such a prominent part in economic exchange in 12th and 13th century Europe; then through banks; and finally through financial houses that could specialize in discounting. These developments were a function not only of specific institutions but also of the scale of economic activity. Increasing volume obviously made such institutional developments 9For a much more detailed descriptionand analysisof the evolution of Europeantrade see Tracy (forthcoming),particularlyVolume II. For a game theoretic analysisof one aspect of this trade revivalsee Milgrom,North and Weingast(1990). This content downloaded from 130.126.162.126 on Sun, 9 Nov 2014 20:29:34 PM All use subject to JSTOR Terms and Conditions 106 Journalof EconomicPerspectives possible. In addition to the economies of scale necessary for the development of the bills of exchange, improved enforceability of contracts was critical, and the interrelationship between the development of accounting and auditing methods and their use as evidence in the collection of debts and in the enforcement of contracts was an important part of this process (Yamey, 1949; Watts and Zimmerman, 1983). Still a third innovation affecting the mobility of capital arose from the problems associated with maintaining control of agents involved in long distance trade. The traditional resolution of this problem in medieval and early modern times was the use of kinship and family ties to bind agents to principals. However, as the size and scope of merchant trading empires grew, the extension of discretionary behavior to others than kin of the principal required the development of more elaborate accounting procedures for monitoring the behavior of agents. The major developments in the area of information costs were the printing of prices of various commodities, as well as the printing of manuals that provided information on weights, measures, customs, brokerage fees, postal systems, and, particularly, the complex exchange rates between monies in Europe and the trading world. Obviously these developments were primarily a function of the volume of international trade and therefore a consequence of economies of scale. The final innovation was the transformation of uncertainty into risk. By uncertainty, I mean here a condition wherein one cannot ascertain the probability of an event and therefore cannot arrive at a way of insuring against such an occurrence. Risk, on the other hand, implies the ability to make an actuarial determination of the likelihood of an event and hence insure against such an outcome. In the modern world, insurance and portfolio diversification are methods for converting uncertainty into risks and thereby reducing, through the provision of a hedge against variability, the costs of transacting. In the medieval and early modern world, precisely the same conversion occurred. For example, marine insurance evolved from sporadic individual contracts covering partial payments for losses to contracts issued by specialized firms. As De Roover (1945, p. 198) described: By the fifteenth century marine insurance was established on a secure basis. The wording of the policies had already become stereotyped and changed very little during the next three or four hundred years. ... In the sixteenth century it was already current practice to use printed forms provided with a few blank spaces for the name of the ship, the name of the master, the amount of the insurance, the premium, and a few other items that were apt to change from one contract to another. Another example of the development of actuarial, ascertainable risk was the business organization that spread risk through either portfolio diversifica- This content downloaded from 130.126.162.126 on Sun, 9 Nov 2014 20:29:34 PM All use subject to JSTOR Terms and Conditions DouglassC. North 107 tion or institutions that permitted a large number of investors to engage in risky activities. For example, the commenda was a contract employed in long distance trade between a sedentary partner and an active partner who accompanied the goods. It evolved from its Jewish, Byzantine, and Muslim origins (Udovitch, 1962) through its use at the hands of Italians to the English Regulated Company and finally the Joint Stock Company, thus providing an evolutionary story of the institutionalization of risk. These specific innovations and particular institutional instruments evolved from interplay between two fundamental economic forces: the economies of scale associated with a growing volume of trade, and the development of improved mechanisms to enforce contracts at lower costs. The causation ran both ways. That is, the increasing volume of long distance trade raised the rate of return to merchants of devising effective mechanisms for enforcing contracts. In turn, the development of such mechanisms lowered the costs of contracting and made trade more profitable, thereby increasing its volume. The process of developing new enforcement mechanisms was a long one. While a variety of courts handled commercial disputes, it is the development of enforcement mechanisms by merchants themselves that is significant. Enforceability appears to have had its beginnings in the development of internal codes of conduct in fraternal orders of guild merchants; those who did not live up to them were threatened with ostracism. A further step was the evolution of mercantile law. Merchants carried with them in long distance trade mercantile codes of conduct, so that Pisan laws passed into the sea codes of Marseilles; Oleron and Lubeck gave laws to the north of Europe, Barcelona to the south of Europe; and from Italy came the legal principle of insurance and bills of exchange (Mitchell, 1969, p. 156). The development of more sophisticated accounting methods and of notarial records provided evidence for ascertaining facts in disputes. The gradual blending of the voluntaristic structure of enforcement of contracts via internal merchant organizations with enforcement by the state is an important part of the story of increasing the enforceability of contracts. The long evolution of merchant law from its voluntary beginnings and the differences in resolutions that it had with both the common and Roman law are a part of the story. The state was a major player in this whole process, and there was continuous interplay between the state's fiscal needs and its credibility in its relationships with merchants and the citizenry in general. In particular, the evolution of capital markets was critically influenced by the policies of the state, since to the extent the state was bound by commitments that it would not confiscate assets or use its coercive power to increase uncertainty in exchange, it made possible the evolution of financial institutions and the creation of more efficient capital markets. The shackling of arbitrary behavior of rulers and the development of impersonal rules that successfully bound both the state and voluntary organizations were a key part of this whole process. The development of an institutional process by which government debt could be circulated, become a This content downloaded from 130.126.162.126 on Sun, 9 Nov 2014 20:29:34 PM All use subject to JSTOR Terms and Conditions 108 Journal of EconomicPerspectives part of a regular capital market, and be funded by regular sources of taxation was also a key part (Tracy, 1985; North and Weingast, 1989). It was in the Netherlands, Amsterdam specifically, that these diverse innovations and institutions were combined to create the predecessor of the efficient modern set of markets that make possible the growth of exchange and commerce. An open immigration policy attracted businessmen. Efficient methods of financing long distance trade were developed, as were capital markets and discounting methods in financial houses that lowered the costs of underwriting this trade. The development of techniques for spreading risk and transforming uncertainty into actuarial, ascertainable risks as well as the creation of large scale markets that allowed for lowering the costs of information, and the development of negotiable government indebtedness all were a part of this story (Barbour, 1949). Contrasting Stories of Stability and Change These contrasting stories of stability and change go to the heart of the puzzle of accounting for changes in the human economic condition. In the former cases, maximizing activity by the actors will not induce increments to knowledge and skills which will modify the institutional framework to induce greater productivity; in the latter case, evolution is a consistent story of incremental change induced by the private gains to be realized by productivity-raising organizational and institutional changes. What distinguished the institutional context of western Europe from the other illustrations? The traditional answer of economic historians has been competition among the fragmented European political units accentuated by changing military technology which forced rulers to seek more revenue (by making bargains with constituents) in order to survive (North and Thomas, 1973; Jones, 1981; Rosenberg and Birdzell, 1986). That is surely part of the answer; political competition for survival in early modern Europe was certainly more acute than in other parts of the world. But it is only a partial answer. Why the contrasting results within western Europe? Why did Spain, the great power of 16th century Europe, decline while the Netherlands and England developed? To begin to get an answer (and it is only a beginning), we need to dig deeper into two key (and related) parts of the puzzle: the relationship between the basic institutional framework, the consequent organizational structure, and institutional change; and the path dependent nature of economic change that is a consequence of the increasing returns characteristic of an institutional framework. In the institutional accounts given earlier, the direction and form of economic activity by individuals and organizations reflected the opportunities thrown up by the basic institutional framework of customs, religious precepts, This content downloaded from 130.126.162.126 on Sun, 9 Nov 2014 20:29:34 PM All use subject to JSTOR Terms and Conditions Institutions 109 and formal rules (and the effectiveness of enforcement). Whether we examine the organization of trade in the Suq or that in the Champagne Fairs, in each case the trader was constrained by the institutional framework, as well as the traditional constraints common to economic theory. In each case the trader would invest in acquiring knowledge and skills to increase his wealth. But in the former case, improved knowledge and skills meant getting better information on opportunities and having greater bargaining skills than other traders, since profitable opportunities came from being better informed and being a more skilled bargainer than other traders. Neither activity induced alteration in the basic institutional framework. On the other hand, while a merchant at a medieval European Fair would certainly gain from acquiring such information and skills, he would gain also from devising ways to bond fellow merchants, to establish merchant courts, to induce princes to protect goods from brigandage in return for revenue, to devise ways to discount bills of exchange. His investment in knowledge and skills would gradually and incrementally alter the basic institutional framework. Note that the institutional evolution entailed not only voluntary organizations that expanded trade and made exchange more productive, but also the development of the state to take over protection and enforcement of property rights as impersonal exchange made contract enforcement increasingly costly for voluntary organizations which lacked effective coercive power. Another essential part of the institutional evolution entails a shackling of the arbitrary behavior of the state over economic activity. Path dependence is more than the incremental process of institutional evolution in which yesterday's institutional framework provides the opportunity set for today's organizations and individual entrepreneurs (political or economic). The institutional matrix consists of an interdependent web of institutions and consequent political and economic organizations that are characterized by massive increasing returns.10 That is, the organizations owe their existence to the opportunities provided by the institutional framework. Network externalities arise because of the initial setup costs (like the de novo creation of the U.S. Constitution in 1787), the learning effects described above, coordination effects via contracts with other organizations, and adaptive expectations arising from the prevalence of contracting based on the existing institutions. When economies do evolve, therefore, nothing about that process assures economic growth. It has commonly been the case that the incentive structure provided by the basic institutional framework creates opportunities for the consequent organizations to evolve, but the direction of their development has 10The concept of path dependence was developed by Brian Arthur (1988, 1989) and Paul David (1985) to explore the path of technological change. I believe the concept has equal explanatory power in helping us understand institutional change. In both cases increasing returns are the key to path dependence, but in the case of institutional change the process is more complex because of the key role of political organizations in the process. This content downloaded from 130.126.162.126 on Sun, 9 Nov 2014 20:29:34 PM All use subject to JSTOR Terms and Conditions 110 Journal of EconomicPerspectives not been to promote productivity-raisingactivities.Rather,private profitability has been enhanced by creating monopolies, by restricting entry and factor mobility, and by political organizationsthat established property rights that redistributedrather than increasedincome. The contrastinghistoriesof the Netherlandsand Englandon the one hand and Spain on the other hand reflected the differing opportunity sets of the actors in each case. To appreciatethe pervasiveinfluence of path dependence, let us extend the historical account of Spain and England to the economic history of the New World and the strikingcontrast in the history of the areas north and south of the Rio Grande River. In the case of North America, the English colonies were formed in the centurywhen the struggle between Parliamentand the Crownwas coming to a head. Religious and politicaldiversityin the mother country was paralleledin the colonies. The general developmentin the directionof local politicalcontrol and the growth of assemblieswas unambiguous.Similarly,the colonist carried over free and common socage tenure of land (fee simple ownershiprights) and secure property rights in other factor and product markets. The French and Indian War from 1755-63 is a familiarbreakingpoint in American history. British efforts to impose a very modest tax on colonial subjects,as well as curb westwardmigration,produced a violent reaction that led via a series of steps, by individualsand organizations,to the Revolution,the Declaration of Independence, the Articles of Confederation, the Northwest Ordinance, and the Constitution,a sequence of institutionalexpressions that formed a consistent evolutionary pattern despite the precariousnessof the process. While the AmericanRevolutioncreated the United States,post-revolutionary history is only intelligible in terms of the continuity of informal and formal institutionalconstraintscarried over from before the Revolution and incrementallymodified (Hughes, 1989). Now turn to the Spanish (and Portuguese)case in Latin America. In the case of the Spanish Indies, conquestcame at the precise time that the influence of the CastilianCortes(parliament)was declining and the monarchyof Castile, which was the seat of power of Spain, was firmly establishing centralized bureaucraticcontrol over Spain and the Spanish Indies." The conquerors imposed a uniform religion and a uniform bureaucraticadministrationon an already existing agriculturalsociety. The bureaucracydetailed every aspect of politicaland economic policy. There were recurrentcrises over the problem of agency. Wealth-maximizingbehavior by organizations and entrepreneurs (political and economic) entailed getting control of, or influence over, the bureaucraticmachinery.While the nineteenth century Wars of Independence in LatinAmericaturned out to be a struggle for control of the bureaucracyand consequent policy as between local colonial control and imperial control, nevertheless the struggle was imbued with the ideological overtones that "The subsequent history of Spanish rise and decline is summarized in North and Thomas (1973). This content downloaded from 130.126.162.126 on Sun, 9 Nov 2014 20:29:34 PM All use subject to JSTOR Terms and Conditions Douglass C. North 111 stemmed from the American and French revolutions. Independence brought U.S.-inspired constitutions, but the results were radically different. In contrast to those of the United States, Latin American federal schemes and efforts at decentralization had one thing in common after the Revolutions. None worked. The gradual country-by-country reversion to centralized bureaucratic control characterized Latin America in the 19th century.12 The divergent paths established by England and Spain in the New World have not converged despite the mediating factors of common ideological influences. In the former, an institutional framework has evolved that permits complex impersonal exchange necessary to political stability as well as to capture the potential economic benefits of modern technology. In the latter, "personalistic" relationships are still the key to much of the political and economic exchange. They are the consequence of an evolving institutional framework that has produced erratic economic growth in Latin America, but neither political nor economic stability, nor realization of the potential of modern technology. The foregoing comparative sketch probably raises more questions than it answers about institutions and the role that they play in the performance of economies. Under what conditions does a path get reversed, like the revival of Spain in modern times? What is it about informal constraints that gives them such a pervasive influence upon the long-run character of economies? What is the relationship between formal and informal constraints? How does an economy develop the informal constraints that make individuals constrain their behavior so that they make political and judicial systems effective forces for third party enforcement? Clearly we have a long way to go for complete answers, but the modern study of institutions offers the promise of dramatic new understanding of economic performance and economic change. * I would like to thank the editorsof thisjournal for their commentson an earlier draft, which has resulted in substantial improvementsin this essay, and Elisabeth Case for editorial improvements.This essay is based in part on a forthcoming bookby the author entitled Institutions, Institutional Change, and Economic Performance. 12For a summary account of the Latin American experience, see Veliz (1980) or Glade (1969). References Arthur, W. Brian, "Self-Reinforcing Mechanisms in Economics." In Anderson, Phillip W., Kenneth J. Arrow, and David Pines, eds., The Economy as an Evolving ComplexSystem. Reading, MA: Addison-Wesley, 1988. Arthur, W. Brian, "Competing Technologies, Increasing Returns, and Lock-In by Historical Events," Economic Journal, 1989, 99, 116-31. Barbour, Violet, "Capitalism in Amsterdam in the Seventeenth Century," Johns Hopkins University Studies in Historical and Political Science, Volume LXVIII. Baltimore: The Johns Hopkins University Press, 1949. The CambridgeEconomic History. Cambridge: Cambridge University Press, 1966. Chandler, Alfred, The Visible Hand. Cambridge: The Belknap Press, 1977. This content downloaded from 130.126.162.126 on Sun, 9 Nov 2014 20:29:34 PM All use subject to JSTOR Terms and Conditions 112 Journalof EconomicPerspectives Colson,Elizabeth, Traditionand Contract:The Problemof Order.Chicago: Adeline Publishing, 1974. Curtin, Philip D., Cross-CulturalTrade in WorldHistory.Cambridge: Cambridge University Press, 1984. David, Paul, "Clio and the Economics of QWERTY," American Economic Review, 1985, 75, 332-37. De Roover, F. E., "Early Examples of Marine Insurance," Journal of Economic History, November 1945, 5, 172-200. Geertz, C., H. Geertz, and L. Rosen, Meaning and Order in Moroccan Society.Cambridge: Cambridge University Press, 1979. Glade, W. P., The Latin AmericanEconomies: A Study of Their Institutional Evolution. New York: American Book, 1969. Greif, Avner, "Reputation and Economic Institutions in Medieval Trade: Evidences from the Geniza Documents," Joumnalof EconomicHistory, 1989. Hughes, J.R. T., "A World Elsewhere: The Importance of Starting English." In Thompson, F. M. L., ed., Essays in Honor of H. J. Habakkuk. Oxford: Oxford University Press, 1989. Jones, E. L., The EuropeanMiracle: Environments, Economies,and Geopoliticsin the Historyof Europe and Asia. Cambridge: Cambridge University Press, 1981. Kalt, J. P. and M. A. Zupan, "Capture and Ideology in the Economic Theory of Politics," AmericanEconomicReview, 1984, 74, 279-300. Lopez, Robert S., and Irving W. Raymond, Medieval Tradein the MediterraneanWorld.New York: Columbia University Press, 1955. Milgrom, P. R., D. C. North, and B. R. Weingast, "The Role of Institutions in the Revival of Trade: The Medieval Law Merchant," Economicsand Politics, March 1990, II. Mitchell, William, An Essay on the Early History of the Law Merchant. New York: Burt Franklin Press, 1969. Nelson, Douglas, and Eugene Silberberg, "Ideology and Legislator Shirking," Economic Inquiry,January 1987, 25, 15-25. North, Douglass C., "Location Theory and Regional Economic Growth," Journal of Political Economy,June 1955, LXIII, 243-258. North, Douglass C., Structureand Change in EconomicHistory. New York: Norton, 1981. North, Douglass C., and Robert Thomas, The Rise of the WesternWorld:A New Economic History. Cambridge: Cambridge University Press, 1973. North, Douglass C., and Barry R. Weingast, "The Evolution of Institutions Governing Public Choice in 17th Century England," Journal of EconomicHistory,November 1989, 5, 172-200. Posner, Richard, "A Theory of Primitive Society, with Special Reference to the Law," Journal of Law and Economics, April 1980, XXIII, 1-54. Rosenberg, Nathan, and L. E. Bridzell, How the WestGrewRich: The EconomicTransformation of the Industrial World.New York: Basic Books, 1986. Stiglitz, Joseph, "Markets, Market Failures, and Development," AmericanEconomicReview, 1989, 79, 197-203. Tracy, James, A Financial Revolution in the HapsburgNetherlands:Rentersand Rentiersin the Countryof Holland, 1515-1565. Berkeley: University of California Press, 1985. Tracy, James, The Rise of MerchantEmpires. Cambridge: Cambridge University Press, forthcoming. Udovitch, Abraham, "At the Origins of the Western Commenda: Islam, Israel, Byzanteum?" Speculum, April 1962, XXXVII, 198207. Veliz, C., The Centralist Tradition of Latin America.Princeton: Princeton University Press, 1980. Wallis, John J., and Douglass C. North, "Measuring the Transaction Sector in the American Economy, 1870-1970." In Engermann, Stanley, and Robert Gallman, eds., Incomeand Wealth:Long-TermFactorsin Amenrcan Economic Growth. Chicago: University of Chicago Press, 1986. Watts, R., and J. Zimmerman, "Agency Problems, Auditing, and the Theory of the Firm: Some Evidence," Journal of Law and Economics,October 1983, XXVI, 613-633. Williamson, Oliver E., Marketsand Hierarchies: Analysis and Antitrust Implications. New York: Free Press, 1975. Williamson, Oliver E., The EconomicInstitutions of Capitalism.New York: Free Press, 1985. Yaney, B. S., "Scientific Bookkeeping and the Rise of Capitalism," EconomicHistory Review, Second Series, 1949, II, 99-113. This content downloaded from 130.126.162.126 on Sun, 9 Nov 2014 20:29:34 PM All use subject to JSTOR Terms and Conditions Response Paper #2 Before beginning this assignment, please read one of the articles in the Response Paper #2 folder. Then please type your answers within this file, then save it and upload it to the corresponding Compass assignment. Each question will be graded out of 5 points. A full credit answer will typically require at least several sentences. The grade for each question will be determined by the thoughtfulness of your answer and your demonstrated ability to comprehend the article and the specific issues raised by each question. The rubric is as follows: 5 points: The question was answered fully. The issue raised in the question was addressed directly, concisely, and with an appreciation for the complexity of the subject matter. 4 points: The question is answered correctly but important details are missing, the point was not fully grasped, or an error is made that doesn't detract from the main point. 3 points: The issue was addressed, though not completely. The answer was off-point or unclear, or the answer was not concise (e.g. rambling, bringing up irrelevant information, etc.) 2 points: Some coherent point was made, but it didn't properly answer the question being asked. 1 point: Some coherent point was made, but it didn't properly answer the question being asked. 0 points: The answer was incoherent, nonsensical, or simply left blank. In addition, points may be deducted for grammar or spelling errors that affect the reader's comprehension of your answer. Please read the article at least once before you begin the assignment. It will often be the case that you can provide a superficial answer to a question after only reading the abstract of the article, but that a complete (i.e. full credit) answer requires more detail, obtainable only by reading and thinking critically about the entire article. Question 1 is worth 10 points, and a similar rubric will apply for that question but with double the point values described above. 1. On p. 97 North writes: "Cooperation is difficult to sustain when the game is not repeated (or there is an endgame), when information on the other players is lacking, and when there are large numbers of players." For each of these three, concisely describe why this is the case. (Note that this question is worth 6 points instead of the usual 3 points.) 2. In describing the transition from local trade within a village or between nearby villages to long distance trade, North writes on p.99: "The development of longdistance trade, perhaps through caravans or lengthy ship voyages, requires a sharp break in the characteristics of an economic structure." According to North what is the key difference between a society in which people are engaged only in local trade and a society in which people are also engaged in longdistance trade--the "sharp break" in characteristics? According to North, how is this related to the concept of "economies of scale"? 3. On pp. 99-100 North describes "two distinct transaction cost problems" that long distance trade entails: agency problems and contract enforcement. What is the difference between these two? 4. On p. 101 North writes: "The technology associated with the growth of manufacturing ... required effective factor and product markets." He then goes on to write: "Undergirding such markets are secure property rights." Describe in more detail why property rights are important to "effective factor and product markets," and why this is contrasted with the case of "local exchange within the village" described on p. 99. In other words, why are secure property rights more important for the growth of manufacturing than they are for an economy characterized by local production and exchange within one village? 5. Pundits often decry the fact that the percentage of the American labor force employed in manufacturing has been falling for the past several decades. Using this article as a guide, explain how North would respond to this. 6. According to North, why do "inefficient" forms of bargaining continue in the Suq? Why don't the institutions of the Suq evolve to resemble those of the more productive modern capitalist societies? 7. In the 1800s, as countries in Latin America fought for and won independence from European colonial powers, they adopted constitutions that closely resembled the US Constitution. With such similar political structures, why did the US experience sustained economic growth, while most Latin American countries experienced only erratic economic growth, and political and economic instability? Concisely describe North's argument. Response Paper Instructions The basic goal of these assignments is for you not only to learn about specific events in economic history, but also to learn to read and understand peer-reviewed academic journal articles in economics. For each response paper you will be writing about one article in particular. For response papers 2, 3, 5, and 6 there are multiple articles for you to choose from. For response papers 1, 4, and 7 there is only one article for each assignment. In addition to the article you will write about directly, you should also read other related material, including other academic journal articles in the Course Content section on Compass, the textbook, or resources that you find on your own. After your reading you can click on the assignment link to submit your answers. My use of the term “paper” to describe this assignment is somewhat misleading, because you will not be writing a single piece, but a series of answers to specific questions. The purpose of this is to guide you through the process of reading and analyzing an academic article. If you wanted to, you could assemble these separate answers into one paper, but keeping them separate helps you keep your thoughts organized and it helps me grade more efficiently. Here are the directions and grading rubric, which you will see when you open each assignment: Please answer each of the following questions. Each question will be graded out of 5 points. A full credit answer will typically require at least several sentences. The grade for each question will be determined by the thoughtfulness of your answer and your demonstrated ability to comprehend the article and the specific issues raised by each question. Note that simply answering the question correctly does not constitute a full credit answer. The rubric is as follows: • • • • • • 5 points: The question was answered fully. The issue raised in the question was addressed directly, concisely, and with an appreciation for the complexity of the subject matter. 4 points: The question is answered correctly but important details are missing, the point was not fully grasped, or an error is made that doesn't detract from the main point. 3 points: The issue was addressed, though not completely. The answer was off-point or unclear, or the answer was not concise (e.g. rambling, bringing up irrelevant information, etc.) 2 points: Some coherent point was made, but it didn't properly answer the question being asked. 1 point: Some coherent point was made, but it didn't properly answer the question being asked. 0 points: The answer was incoherent, nonsensical, or simply left blank. In addition, points may be deducted for grammar or spelling errors that affect the reader's comprehension of your answer. Each response paper has a due date, indicated on Compass. You have to submit the paper by that date or you will get a zero for that assignment. There are no exceptions; you will have plenty of time to do the assignments, so if you are concerned about the possibility of technological problems or other issues then you can submit them early, before the due date. Please note that because of the way Compass works, the due time on the due date is 11:59pm and zero seconds, NOT 11:59 and 59 seconds. So if you are going to submit a response paper at literally the last minute, note that the last minute is 11:58, not 11:59. Note also that Compass has a time-out period for inactivity (probably one hour; this is set at the university level and I have no control over it). How to Read an Academic Article Academic journal articles are peer-reviewed. What this means is that before they are published, other people who specialize in the topic of the article will read it and advise the journal’s editor about whether it is worth publishing. Generally, in order to be worth publishing an article has to show awareness of other work on the same topic, it has to present some new argument or new information, and it has to be well supported by logic and evidence. Different journals have different methods, but in economics the typical procedure works like this: First, an economist does some research, individually or with other people. This could be historical research, data analysis, math modeling, or something else, depending on the topic. Often—though not always—the results of this research are presented at an academic conference. At those conferences, there are other economists present who will raise questions or criticisms of the work. The second big step is that the author or authors will write up the article and send it to a journal. The same paper can only be sent to one journal at a time. So while one journal is looking at it and considering whether to accept it, you can’t simultaneously send it to other journals. (This is not the case in some fields, but it is in economics.) The third step is peer review. The editor will send the article out to two or three other scholars who specialize in the topic. Those reviewers will read the article and choose one of three options to tell the editor: 1) publish it, 2) reject it, or 3) revise and resubmit. If they choose “revise and resubmit,” they tell the editor what was wrong with the paper, and what should be fixed before it can be accepted. The editor then makes the final decision about what to do, and conveys the reviewers’ comments anonymously to the article’s authors. This anonymity is part of the process. Sometimes the reviewers know who the authors are, and sometimes they don’t—different journals have different policies. But what is universal is that the authors never know who the reviewers are. They can only read the comments. The last step is that if the editor has decided to accept the paper, then they publish it in the next issue of the journal. If the editor decides to reject it, the author can choose to send it to another journal if they want. Because of the nature of the peer-review process and the expectations of new articles, there is a typical pattern to the way these articles are written. They usually have an abstract at the beginning, before the article itself. This just summarizes the point of the article. Some articles don’t have one; every journal has its own policy on this. The first part of the actual article, after the introductory paragraph, is what is called a literature review (lit review). This is a summary of other scholars’ work on the subject. This serves three purposes: 1. If authors have to read all previous work on the subject, this avoids situations where they just repeat something that someone else has already written, and don’t contribute anything new. 2. It sets up the terms of the debate. Academic articles are arguments. In cases where the topic is under debate, the argument may be that someone else is wrong. In cases where the topic is new, the argument may just be that this issue deserves people’s attention. But in either case, the writing is framed as an argument, and the lit review helps lay out the context in which the argument is being made. 3. Readers who are not familiar with the specific topic at hand can use the lit review as a guide to what else they should read if they want to look into it in more detail. After the lit review the authors typically start making their argument, including whatever logic and evidence they have for it. There might be examples, data analysis, analogous situations, or something else. After the argument, or sometimes as a part of it, authors take some time to address opposing views. Ideally, this means finding the best argument against your position and explaining why that viewpoint is less convincing than your own. Finally, at the end some authors will include related issues that might be too small to publish in separate articles. This may involve a repeat in miniature of all the previous steps, with a new short lit review, a concise argument, and a brief response to opposing views. Or it might just elaborate on other material in the main part of the article. Knowing how to read academic journal articles is rewarding, and useful, and hopefully fun. And that’s partly what these response papers are intended to teach you. Having to read real academic articles that were written for professional economists, and answer the response paper questions, will not only teach you the specific subjects about which the articles were written; it will also teach you how academic research, writing, and debate is conducted. How to Do Well on the Response Papers This might sound obvious, but answer the questions that are being asked. For example, if the question asks you to "describe the viewpoint that the author is responding to" and you instead describe the author's own viewpoint, you will not get credit. In the past, this type of mistake has been the most common reason for lost points. Read each question carefully before you answer it, then again after you answer it just to double check. Don’t simply quote the author. Explain your answer in your own words. If the question asks for a supporting quote, then of course provide one. But note that the quote is there for support only. You still need to answer the question yourself. Read (a lot) before you write. Read several different articles and pick the one you think you can do best on. Once you have chosen, read other articles and book chapters that are related to the same topic. Look up the topic online to get more information. Read the questions in the response paper assignment. (You can open the response paper, close it, and come back to it as many times as you want before the due date, as long as you don't click "Submit" until you are done.) After you read, think. Take a day or two to go over it all in your mind. If you do this, your answers will be much more thoughtful, and get a higher grade. Of course, to do this you have to start at least a week ahead of time. For response papers 1, 4, and 7 the questions are tailored to the paper being assigned. The other response papers give you a choice between a number of different articles. Because different students choose different papers, these assignments will use this set of more generic questions: 1. 2. 3. 4. 5. 6. 7. 8. Which article did you choose to write about? Include the year, author’s name, and article title. (Note that your answer to this question actually does count towards your grade on this assignment.) Concisely describe the viewpoint that the author is responding to with this article. Summarize the reasoning and/or evidence that has been offered to support this viewpoint. According to the author, what is the most important problem with this viewpoint? What viewpoint does the author argue for instead? What reasoning or evidence does the author provide to support his or her own viewpoint? What further evidence, if discovered, might strengthen the author’s argument? What further evidence, if discovered, might weaken the author’s argument? The last two questions are the most important and also the most difficult. These require more active, personal, creative thought than the others, which are mostly about making sure you understand the nature and context of the author’s argument. As these are open ended questions, a number of different full-credit answers are possible. However, there are several types of answers that will earn few, if any, points: "More of the same" and "If the author's data is in error…" Here's the basic idea: We use evidence to establish a certain level of confidence in a position, but that level is always less than 100%. For example, if you park your car in a bad neighborhood, then return to find it missing, based on the evidence you would probably conclude that it was stolen. But that wouldn't be a position in which you have 100% confidence. And even if your confidence level is high, other evidence could arise that would weaken that position. For example, imagine you then discover that the spare car key in your home is missing, and that one of your friends who stayed at your house recently lives near that bad neighborhood. Now it might seem more likely that your friend borrowed your car for some emergency. This new evidence reduces your confidence in your previous position--it "weakens the argument" that your car was stolen. That's the approach I want you to take towards these two questions. For the question on what would strengthen the author's argument, the reason why I don't want to see answers that are just "more of the same" is because it misses the point, which is to think about the various types of data that could be studied to learn more about the issue. To use the car analogy above, it would be as if another person testified that you parked your car, and then when you returned it was gone. It's just saying something that we already know. For the question on what would weaken the author's argument, the reason I don't want to see answers that just say "if this data was found to be in error" is because that is, again, missing the point. The authors of these articles are professionals and their findings have been peer reviewed. The chance that the data is in error is very small. By contrast, their interpretation of the data has a higher chance of being wrong. And the way to find out if this is the case is to find more information. That's what I want you to think about. To use the car analogy above, if you think your car is stolen, it is not helpful for me to say "Well, you thought you parked your car there and then it was gone, but what if you're wrong?" It's not helpful because if you believe your car has been stolen, you will obviously think very carefully about where you parked it and make sure this wasn't a simple mistake. The chance that you simply forgot where you parked it, then jumped to the conclusion that it was stolen, and never realized this error even after reporting it to the police and telling all of your friends about the theft, is very small. On the other hand, new evidence (your missing spare key, your friend's situation, etc.) that fits with the existing evidence but points to a new conclusion, would certainly weaken your position that it was stolen. Note that the goal is not to describe evidence that would cause the author to change his or her mind. The goal is to describe evidence that would strengthen or weaken the argument. To apply this to the car example, if you are 80% certain that your car has been stolen, discovering that the spare car key in your home is missing might reduce your certainty to 70%. If someone were to ask you if you believe your car was stolen, you would still answer “yes.” You haven’t changed your mind. But the argument that your car has been stolen is weaker than it was before. Approach these assignments with this in mind. Even if you think an author has made a superb argument, supported by extensive amounts of data, it is still the case that no argument is airtight. It is always possible to find evidence that would weaken the argument. The point is to think about what that evidence would look like. Let me give you another example. Data indicates that among Christians in the United States, those who attend church regularly are, on average, healthier. Based on this data, some have concluded that this means that going to church is good for your health. This is their argument. Now, what if the same type of pattern in the data was found in Canada as well as the United States? Would this strengthen the argument? Not really--or, at least, not by much. Why not? Because whatever is causing this pattern in the US would most likely cause the same pattern in Canada. And if there is something wrong with the interpretation, it will be equally wrong in Canada. Finding "more of the same" evidence is not all that meaningful. So what is actually wrong with the interpretation? It reverses causation. Going to church is not causing people to be healthier. Unhealthy people are, on average, less likely to be physically capable of getting out of the house and traveling to church. Health levels determine church attendance, not the other way around. Now you can see why "more of the same" evidence is not useful. If health levels determine church attendance in the US, then they probably determine church attendance everywhere. Finding more examples of the same pattern doesn't make it any more likely that church attendance makes people healthy. It just confirms that a correlation does exist, which we already know from the data we have on the US. Likewise, if someone says "data indicate that church attendance and health are correlated, therefore going to church makes you healthier", it would be pointless to oppose the argument by saying "Oh yeah? But what if that data is wrong?" As it turns out, in reality the data is correct. The correlation does really exist. What is incorrect is the interpretation of the data. And in order to see that, you need to come up with other evidence or reasoning that fits the evidence we already have but points in a new direction. To be clear, this does not mean that it is never acceptable to challenge somebody’s data. But the point is that the challenge must itself be grounded in evidence. The author Christopher Hitchens once wrote: “What can be asserted without evidence can be dismissed without evidence.” The same principle applies when the assertion is that somebody’s data is in error. Let me frame this a bit more concretely. In the papers that you will read the authors have presented data and drawn conclusions. These conclusions have a certain probability of being true. Question 8 asks you to describe data that would weaken these conclusions—i.e. that would reduce the probability that the conclusions are true. Simply stating “the data might be wrong” does not do that, because data can always be wrong, and everybody already knows this. So for example, imagine an author gathers data, analyzes it, and on that basis concludes that toogits cause novanoids (these are imaginary words). Let’s say you estimate that this conclusion has an 80% probability of being true. Then along comes a critic, and this person says “But the data could be wrong!” After this, what is your estimate of the probability that this conclusion is true? It is still 80%. It hasn’t changed, because you don’t have any new information. You already knew that it was possible that the data could be wrong. That’s part of the reason why your estimate was 80% and not 100%. By contrast, imagine that the critic says “This data might not be representative because the author gathered it using surveys, and we know that the presence of novanoids increases survey response rates, and the author has not controlled for this bias.” Assuming that you really do believe that the presence of novanoids increases survey response rates, and this specific insight is new to you (it is not something that you accounted for in your previous estimate), then this argument would reduce your estimate of the probability that the conclusion is true. In essence, a challenge to the data amounts to saying: “If I gathered data the results would be different from this author’s.” In order for this to carry any weight, you would need to explain why the results would be different. Finally, it should be clear that “less of the same” is similar to “more of the same.” In other words, the claim that the author’s argument would be strengthened if data from another country showed the same pattern, is fundamentally similar to the claim that the author’s argument would be weakened if data from another country showed a different pattern. Both claims are true, but both are weak answers to questions 7 and 8, and will not earn many points. Describing the interpretation instead of describing the evidence Another common pitfall to avoid is the mistake of describing an interpretation of evidence rather than the evidence itself. To continue the earlier example involving church attendance and health, imagine somebody gave as the answer to #8: “If evidence was discovered that indicated that church attendance didn’t cause health to improve, this would weaken the argument.” Notice that this does not actually answer the question being asked. The question is asking for a description of evidence, and this response does not describe evidence. It describes somebody’s interpretation of some evidence, but we are not actually told what that evidence might be. This is basically just restating the question. “Q: What evidence would weaken the argument? A: If evidence was found that weakened the argument, that would weaken the argument.” This is a non-answer. Here is a better answer: “If we found data that showed a similar correlation between attendance at other venues (e.g. school classes, movie theaters, or even satanic rock concerts) and health, this would imply that church attendance was not uniquely related to health. Perhaps an argument might still be made that leaving the house improved one’s health, and that church attendance is one reason to leave the house. But the argument that there is a causal link between church attendance in particular, and health outcomes, would be weakened.” Evidence from hypothetical future events Imagine an economist is studying the effects of a certain law, and argues that the law caused the interest rate to rise from 5% to 10%. You might be tempted to write something like: “If the law was repealed and the interest rate fell from 10% to 5%, this would strengthen the author’s argument.” While this is true, it’s not a good answer. The reason is because in the social sciences evidence almost never comes from laboratory experiments, but from real world events. We don’t get to alter the legal system just to test our hypotheses. It might be nice to think about what events might occur that would give us useful data, but in practice what separates good empirical economists from bad ones is the ability to tease unexpected insight out of events that have already occurred. This is why the questions are phrased as “What further evidence, if discovered…” as opposed to “What future events, if they occurred…” Note that in many natural science contexts, a focus on “future events” is the norm; this is in essence what experimentation is about. The experimenter forms a hypothesis and then intentionally creates a future event in a controlled setting in order to test it. So the problem with this type of answer in this class is not that it is invalid reasoning or bad science, but that it is rarely practicable in the particular field of science in which economists and economic historians work. “Diary Entries” The last mistake that I will describe is what I call the “diary entries” answer. This is when somebody posits, as “new evidence,” personal accounts (such as diary entries) describing the situation being analyzed. For example, if the argument is that American slaves were fed 200 units of food per week, an example of this type of answer might be: “If the diaries of some slaveowners were found that described feeding slaves 300 units of food per week, this would weaken the argument.” The problem with this answer is not that it is false, but that it is very weak. There are two primary reasons. First, personal accounts are anecdotal evidence, which is weak support for a general claim like this one because the sample size is small relative to the population and the experiences of certain individuals may not be representative of the larger group. Second, personal accounts suffer from biases. These can include personal ignorance (does the writer feed the slaves himself?), vested interest (does the writer have a reason to exaggerate?), and the probability of error (a diary is not an accounting book; if the wrong number is written in a diary by mistake it is much less likely to be corrected), among others. To use a variation on the earlier example involving church attendance and health, how reliable are diary entries of churchgoers claiming that going to church cured their illnesses? The answer is: Not very. People who make such claims tend to be ignorant of medical science, they tend to have a strong vested interest in rationalizing their worldview to themselves and others, and cherry-picking is notorious in such cases (miracle claims are typically made for diseases that are difficult to diagnose and for which mistakes and misdiagnoses are more likely, and they are virtually never made for healings that would be easy to verify, such as amputees regrowing limbs). To be clear, this is evidence. It is just very, very weak evidence. For this reason, positing diary entries or other forms of anecdotal evidence in answer to questions 7 and 8 will typically result in a low score. Lastly: If the requirements are not clear or you need help understanding a particular article, ask me!
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Economic Perspectives
1.

Sustaining Corporation Game is Difficult

Cooperation is challenging to maintain when the game is not repeated because there are
organizations which allow low-cost trading, apply specialization, and division of labor in their
products and operations. These institutions feel threatened when the transactions end due to fear
of termination of their service.
When information on other player is lacking, the corporation game becomes difficult.
The primary cause of the situation is the fact that many resources are used in the definition and
enforcing arrangement. In many cases, traders invest in acquiring knowledge and skills to
increase his wealth. Then, in turn, gain better information since better opportunities come from
been informed and learning negotiation skills than competitors (Hodgson 686).
The cooperation when there are large numbers of players- North (99 )notes there are
possibilities of conflicts and disputes as trade develops from a single village trade to longdistance trade. It’s difficult to negotiate or enforce rules and regulations in large numbers of
participants. Thus the rules of the game are valid in recent situations (Hodgson 686).

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2. Difference between the society which engaged in local trade only and a society which
participated in long-distance trade
According to North (99), there was a vital difference between the society which engaged
in local trade only and a society which participated in long-distance trade. The long-distance
trade societies had, also, considerable individual specialization in goods and services exchangethose who were restrained to trading. They also experienced the development of temporary
gathering places or more permanent towns or cities. Those communities’ traders enjoyed
economies of scale. Thus they were different from local trade societies.
The economies of scale were experienced in communities which were involved in longdistance trade. This happened due geographical specialization and intensification of production.
Thus the unit production cost was lowered, and traders experienced marketing.
3.

Difference between Agency and Contract Enforcement Problems.

The growth of long-distance trade had two different transaction cost challenges: agency
problems, and contract enforcement. Agency problems arose from the trader’s relative
negotiation on goods to the sale and returned good/cargo (North 99). There was the challenge of
estimating costliness of measuring performance, the significance of understandings and
agreements, and level of relationship. Generally, the prices defection from countries...


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