Capitalism, Socialism and other terms to be avoided

Capitalism is a term coined, or at least popularised, by the enemies of the system they labelled capitalism. It was understood from the start to have a pejorative connotation and the term’s use is still dominated by that pejorative connotation. Despite the efforts of supporters of capitalism-so-labelled to reclaim capitalism as a positive, or at least neutral, label; particularly based on historical experience.

One should always be wary of any term where the pejorative element built in. Even if you somehow do not let the pejorative element infect your own thought, it is going to be there in the mind of many, often most, readers.

Socialism is a term coined, or at least popularised, by the proponents of the system they labelled socialism. It was understood from the start to have a positive, indeed overwhelmingly positive, connotation and its use is still dominated in many quarters by that positive connotation. This despite the efforts of the opponents of “socialism” to give it thoroughly negative connotations, particularly based on historical experience.

Capitalism has at least has some vague consensus on what the term means. Socialism does not even have that, as recent American politics has demonstrated, thanks to the attempts of Sen. Bernie Sanders, self-proclaimed socialist, to win the Democratic Party nomination for President of the United States.

Capitalism has some vague consensus regarding what the term means because almost everyone agrees that there is currently, and has been, a lot of it. Apart from some labelling of command economies as state capitalism, there is a general consensus that we more or less know capitalism when we see it.

There is no such consensus around socialism, mainly because socialists typically want to dissociate the term from every command economy that has ever operated, or patent embarrassments such as Venezuela. Conversely, the enemies of socialism what to hang every command economy that has ever operated, and embarrassments such as Venezuela, on any use of socialism.

If socialism has never been “really” tried, then it can never have failed. Or if there is this new form or conception of socialism that has never been tried, then clearly it has nothing to do with any command economy that has ever operated, or any embarrassment such as Venezuela.

Of course, one might suspect that this attempt to constantly separate socialism from history might be a bit of a warning sign. Especially if folk want to play the game of comparing the ideal of socialism (carefully separated from history) with the practice of capitalism (often using carefully edited, selected or re-construed bits of history).

For me, there is a simple solution. Avoid, as much as possible, using either term. Then you can at least aspire to some analytical rigour.

Other possibilities

That does not remotely foreclose considering new social possibilities. It just means trying to do so with some analytical precision without dragging along the deadweight of fraught ideological conflicts.

Moreover, contemplating the social possibilities that do not seem to be much explored can be a very useful exercise. To consider the dogs that don’t bark in the night.

If not separating workers from the product of their labour, or simply having the workers in charge, is such a fine thing, one might think that would be entirely possible to set up worker-controlled companies. Then the non-alienated, self-controlled workers might be expected to produce so well that they can outcompete capital-owned firms in the market place.

Of course, if your notion of alienation covers any attempt to produce for exchange, then even in a worker-controlled firm workers will be alienated from their labour. Of course, not producing for exchange then reduces Homo sapiens to the economic level of every other species on the planet. One might consider the possibility that producing for exchange permits the scaling up of production and consumption far more extensively or efficiently than any other way of dealing with the issues of subsistence and surplus. So, perhaps giving up an advantage that may predate our emergence as a species is not a good move.

Let’s assume that something we have been doing for maybe 320,000 years or so (and certainly for 200,000 years), exchanging things we have produced, is not some alienating disaster, and go with worker control is good. Worker-controlled firms is still an entirely possible option. So, why don’t we see far more of such?

What is a firm? A firm is a mechanism for lowering transaction costs and dealing with risk. Do we want to dump risk on to labour or on to capital? Surely, on to capital. So, a labour-controlled firm is going to make the decisions, and is going to need capital, but will also want to dump the risk onto the holders of capital.

So, which firms are going to operate better? Those where control ultimately rests with those who have to deal with the risks or those where control ultimately rests with those who get to systematically dump risk on to others?

Clearly the former. The owners of a capital-owned firm get the residual income from the firm because they also cover the residual losses from the firms.

Moreover, when we say “worker controlled”, which workers? The original workers presumably. But what if you want to hire new staff, do they get the same control rights? Suppose the firm has too many workers, it needs to lay off staff, how do you decide that? What are the dynamics of a group of workers who every so often may have to vote on who gets to be ejected from the firm?

Capital-owned firms solve these problems by essentially having a market in control. The more you are willing to buy in, the more control you have. If you want to leave, you sell your control rights. Decisions about hiring and firing are left with those who are managing the firm. (And firms with mechanisms for workers to become shareholders are still capital-owned firms.)

What about coordination issues as a worker-controlled firm gets bigger?

At this point, we can see why the somewhat Darwinian selection processes of markets select for capital-owned firms and not worker-controlled ones. It is not that worker-controlled firms are illegal, it is that they represent a risk-and-decision profile that no one (including workers) are likely to invest in. The closest we get are partnerships, and they represent human-capital firms, not worker-control.

And about the state

Consider again the question: which firms are going to operate better? Those where control ultimately rests with those who have to deal with the risks or those where control ultimately rests with those who get to dump the risk on to others? Here’s something to conjure with. Is not: a structure where control ultimately rests with those who get to dump the risk on to others, a pretty good description of the state?

People (often with good reason) complain about the socialisation of losses and the privatisation of profits. But that is precisely what an awful lot of state politics is about. Shifting benefits to one group and costs, including risks, to another because the coercive power of the state makes that a game that can be played (and is obviously one with significant potential pay-offs). When one sees risks being shifted from capital to labour, there is generally some state action underlying it.

This is why the term state capitalism has a little bit of purchase behind it. If you squint just right.

In a command economy, the state owns all (or almost all) the capital. So, in a command economy, risk regularly gets dumped by the capital-owning state on to labour. Including risks of mass starvation or environmental degradation. But that is not because capital owns the state, but because the state owns the capital.

Lenin, Stalin, Mao, etc. did not control the state due to their ownership of capital, they controlled the creation and use of capital due to their control of the state. To call such capitalist or capitalism is to get the causal drivers entirely the wrong way around.

So, yes, it is significant that state owns the capital in a command economy. It affects its patterns of behaviour and means there is no significant non-state control of surplus, so no significant basis of institutional resistance to the power of (those who control) the state. But the capital is entirely subordinate to the state. So, the society is not capitalist.

And we are back with avoiding the use of terms so weighed down with emotionally-laden connotations. Because, without those connotations, there would be no incentive to so badly mis-characterise the relevant social, political and economic dynamics.

Ronald Coase 1910 - 2013

Ronald Coase, the 1991 Nobel Memorial Laureate in Economics, passed away on 2 September at the age of 102.  He was working to the end, having recently published a co-authored book on China. A good one.

I have loved Coase's work ever since I first came across it. He won his Nobel Memorial for essentially two articles. One he wrote as an undergraduate in his 20s, the 1937 article The Nature of the Firm (pdf).  The other was published in 1960, The Problem of Social Cost (pdf), the most cited law article. Both pieces, plus his somewhat notorious The Lighthouse in Economics (pdf) and some other key articles and essays, were published in 1988 in his The Firm, the Market and the Law, available on Amazon in Kindle edition for $US15.12.

Buy or do?

Coase is best known for a concept he did not name--transaction costs--and a theorem he did not formulate--the Coase Theorem. The concept of transaction costs first appears in a 1931 article by economist John R. Commons. Coase, however, elaborated the concept and applied to a very practical problem--why do firms exist? Why is not the price mechanism always used? Why does everyone not operate as sole traders trading their services in the market place?

As he sets out in his Nobel Memorial Prize lecture, having completed the course requirements for his degree in Commerce from the LSE in two years, but graduation requiring three years attendance, he spent the third year traveling the US studying vertical and horizontal integration of firms. Thomas Hazlett describes nicely what young Coase did in the introduction to a 1997 interview with Coase:

Coase's scientific methodology? He asked businessmen why they did what they did. One key question, for instance, involved why firms chose to produce some of their own inputs (vertical integration), and why they sometimes chose to use the market (buying from independent suppliers). He was fascinated by their answers, but even more by their astute calculation: Firm managers were keenly aware of all the relevant trade-offs.

Coase identified the costs of transacting as the key variable determining the answer and therefore the existence, and boundaries, of firms. Firms existed because it was cheaper to do some things within a firm than in a market place; that there were costs to using the price mechanism. One of those insights which is blindingly obvious once someone has pointed it out.

Ronald Coase

In doing so, he explicitly disagreed with economist Frank Knight's analysis that risk led to non-market transactions, establishing an on-going pattern where risk and transaction costs are the key factors used by economists to discuss institutional arrangements. For example, Deidre McCloskey and Stefano Fenoaltea's debate over the structure of medieval manors turns very much on the relative importance of transaction costs and risks. Similarly, a paper on (pdf) taxation policy in the Ottoman Empire looks at the balance of risk and transaction costs according to what level taxes were levied at. If risks were more constraining, it made sense to tax at a more territorially encompassing level, so risks could be pooled. If transaction costs were more constraining, it made sense to tax at a more local level, so local knowledge could be used.

Economist Yoram Barzel has offered an analysis of the boundary of the firm which puts risk back at the centre, the boundary being set by the range of transactions guaranteed by the equity capital. Though transaction costs are hardly irrelevant in that decision. Especially as risks can be transferred--to other transactions, to other agents, across time--while risks and transaction costs overlap.

Coase's insight also make it easier to see how the IT revolution and the Internet has affected both the structure of firms and the variety of commercial and other arrangements.

While Coase's insight on the boundary of the firm may be obvious in retrospect, the insight remained remarkably fallow in economics for decades. As Coase himself noted in his Nobel Memorial lecture, the concept needed to be "operationalised", quoting 2009 Nobel Memorial Laureate Oliver Williamson. As was done by such scholars as Williamson himself, Steven Cheung and Harold Demsetz. But informing and inspiring the work of other scholars is what makes great insights intellectually productive.

Social costs going both ways

If the idea at the heart of The Nature of the Firm seems obvious in retrospect, there is nothing obvious in the massively counter-intuitive idea at the heart of Coase's other seminal piece, The Problem of Social Cost, which is that, in a world with costless bargaining, it may make no difference to the net social outcome whether a producer has liability for the damage they cause or not. If they have liability, they can pay others for the damage caused to them. If they have no liability, they can be paid by others not to do the damage. Either way, the same level of production will be agreed to. As Coase himself put it in that 1997 interview:

The law of property determines who owns something, but the market determines how it will be used.

The operative term is in a world of costless bargaining. Coase's intent was to draw attention to the role and importance of law in a world of positive transaction costs and to the reciprocal nature of the problem of damage (i.e. both the doing and the not doing cause costs to someone). But it is much easier to model a world with zero transaction costs. Economists became entranced by the world of what 1982 Nobel Memorial Laureate George Stigler termed the Coase Theorem--that, in a world of zero transaction costs, private and social costs were the same. It was a world without externalities (a term Coase did not approve of) because they could all be bargained away.

This fascination with an unreal zero transaction costs world of tractable models frustrated Coase. As he wrote in Notes on the Problem of Social Costs:

The world of zero transaction costs has often been described as a Coasian world. Nothing could be further from the truth (p.174).

But this unreal world was great for mathematical models. As Coase wrote at the end of Notes on the Problem of Social Costs:

In my youth it was said that what was too silly to be said may be sung. In modern economics it may be put into mathematics (p.185).

It was not that Coase was against the use of mathematics in economics. Far from it. He just wanted the maths to have a strong connection to the world we actually live in.

Which is a world where price mechanisms are not always used because it is a world of positive transaction costs. Hence not only firms but also laws and institutions. Coase's insights became central to analysis of firms, to law--the entire field of law and economics flows from his insights--and economic history. The last is most obvious in the work of 1993 Nobel Memorial Laureate Douglass North with his analysis of institutions as ways of dealing (indeed minimising) transaction costs but it also lurks underneath 1993 Nobel Memorial Laureate Robert Fogel's work on the efficiency of slavery. Anyone who reads a significant amount of economic history becomes very aware of how basic transaction costs are to making sense of history because they are so important to making sense of law, rules and institutions. No wonder economic historians find Coase's insights so useful.

(As an aside, the committee which picks Nobel Memorial Laureates does seem to like folk who extend the ambit of economics, the most imperial of the social sciences.)

Institutions can be analysed longitudinally (across time) but also laterally (across space). Coase's insights are a fundamental building block of 2009 Nobel Memorial Laureate Elinor Ostrom's work on common property and the evolution of rules to manage them.

Coase himself pointed out that what became known as transaction costs had already been basic in economic analysis of the origins of money--particularly in the famous coincidence of wants problem. Search costs are a basic transaction cost and a reason to have money. More recent work on "money is memory" (pdf) and money as a response to limited enforcement is yet another form of transaction cost analysis.

Coase was very aware of the difference in how lawyers and how economists think while linking between the two mindsets. As he notes in The Problem of Social Cost, lawyers are concerned first with establishing who has the legal right to do what, and then working through the consequences. Economists look to what bargains can be made.

Coase pointed out that exchange was not merely about physical items, but about bundles of rights to bundles of attributes. Harold Demsetz's famous beaver trade analysis (pdf) of the origins of property rights based on the cost and benefits of internalising externalities is very much based in such Coasian perspectives.

Coase's insights made it easier to see that any exchange is first and foremost an exchange of ownership. Mere physical possession can be resolved in any particular instance by force; who is functionally stronger and sufficiently motivated? It is accepted rights to which create enduring bargains.

Spreading influence

It is an instructive exercise to go through the list of Nobel Memorial Laureates and see for how many of them their seminal work was based--explicitly or implicitly--on the insights of Ronald Coase. Insights conveyed clearly and lucidly without any more mathematics than simple algebra and arithmetic.  Indeed, his two seminal articles should be read by anyone interested in social analysis.

Ronald Coase was not, however, a public intellectual in the way of Keynes, Hayek, Friedman or Krugman. Though his work was instrumental in developing the key arguments for privatisation: indeed, the Problem of Social Cost was written as a result of a previous article on privatising the radio spectrum being challenged by Milton Friedman and other University of Chicago economists in a memorable night of argument.

Coase drew attention to the necessity of laws, rules and institutions, but also wanted economists to be a bit more sceptical about government intervention than they had been--as he pointed out governments are not immune to transaction costs. One of the reasons he disliked the concept of externalities (apart from obscuring the reciprocal nature of the issue of effects) is because he thought it encouraged intellectually lazy presumptions about government intervention. Particularly when economists did not stop to enquire how much of current private actions rested on government protections and exemptions.

Or whether other possibilities had arisen. Coase's The Lighthouse in Economics points out that the historical record regarding lighthouses does not conform to "no private provision of lighthouses is feasible" presumption of prominent economists. Elinor Ostrom's investigation of the wide range of possibilities between private ownership and government control in governing of common property is very much in the same spirit--yes, but what do people actually do, and why? There is a Coase Institute which seems to be motivated by the spirit of its namesake.

Coase may not have been a public intellectual in the way of more famous economists, but that apparently did not stop him attracting the ire of would-be policers of academic opinion. Both he and 1986 Nobel Memorial Laureate James Buchanan were apparently encouraged to leave (via) the University of Virginia because they were regarded as too "right wing". Coase refers to the hostile sentiment in the aforementioned 1997 interview:

They thought the work we were doing was disreputable. They thought of us as right-wing extremists. My wife was at a cocktail party and heard me described as someone to the right of the John Birch Society. There was a great antagonism in the '50s and '60s to anyone who saw any advantage in a market system or in a nonregulated or relatively economically free system.

A particularly silly view of Coase, as British pragmatism seems to be the best description of his views: but insisting on evidence-based policy can get in the way of all sorts of glib presumptions. As Dr Barry Marshal, the 2005 Nobel Laureate in Medicine, was also encouraged to leave said university, the University of Virginia may have an inglorious record in the number of Nobel Laureates discouraged from working there. (Though comfortable conformity is, I suppose, a branding.)

The economic blogosphere has some fine posts on Coase, with more good things in comment sections. Scott Sumner has a nice short post, Lynne Kiesling has a post with lots of links. Peter Boettke has an nice discussion of Coase's contributions.

Coase himself said of his work that:

I’ve never done anything that wasn’t obvious, and I didn’t know why other people didn’t do it. I’ve never thought the things I did were so extraordinary.

But is not pointing out the obvious-in-retrospect a mark of truly great intellectual contributions? To me, Coase is the most important economist of the C20th as his insights so expanded the ability of economics to usefully analyse social phenomena. If you think that claim of importance is too big a claim, I refer you back to the list of Nobel Memorial Prizes in Economics and how many of them had their seminal work based, at least in part, on Ronald Coase's insights.

Which he originally came to by asking folk about how they reached particular decisions. Businessfolk often seem to be the only living group academics feel entitled to analyse without ever seriously (or even not seriously) talking to any about what they do and why or ever using any work or evidence from someone who had. Here's a challenging thought: without Coase's work, how many economists would be in that situation?

[Cross-posted at Skepticlawyer.]

It's transactions, stupid

If you had to do everything yourself (feed yourself, clothe yourself, shelter yourself), you would be very much poorer than you are now. The ability to specialise and the ability to access resources beyond your immediate vicinity enormously increases your resource use possibilities.

(This, btw, is why "food miles" is such utter crap. It is just a revamping of the late C19th/early C20th "local food" movement. As it was back then, it is richer folk sneering at the only way lower income folk can get cheap food.)

The ability to specialise and to access resources beyond your immediate vicinity relies on transactions. The easier it is to transact, the greater the resource use possibilities. Which is why reduction in transaction costs has been such a key feature in the evolution of mass prosperity. Institutional structures which generate lower transaction costs have tended to be advantaged over those that generate higher transaction costs. More transactions, more resource use possibilities, mean greater social capacity and higher levels of general prosperity.

The trouble is, blocking certain sorts of transactions can be a great way to create or defend privilege. Various forms of social mercantilism restrict the ability to transact, or the ease of transacting, to favoured groups: such as requiring (expensive or time-consuming) official permission. Latin America, for example, has long been bedevilled by that sort of social mercantilism. As has the Middle East (pdf). Such social mercantilism both generates jobs for officials (and possible bribe income) and allows some groups to be advantaged over others.

One sees the same privileging by restricting the ability to transact in many European labour markets: hence high unemployment rates, particularly among young workers. This is a particularly severe problem in Spain.

This is a game that generates problems, particularly for welfare states. Not only does restricting the ability to transact lower the level of economic activity, thereby decreasing the revenue for government; it also increases the reliance on welfare services, raising the expenses for government. Sure, public employment and welfare dependence can be a voter-and-activist base, but one runs into problems of sustainability.

The success of the Australian public policy model has been crucially based on making transacting easier and targeting welfare more precisely, creating a far more sustainable welfare state. A low tax, low debt, low unemployment, high income growth, high low-income growth, public policy model.

Central to this success has been macroeconomic stability founded in a clear monetary policy target. The target is an average of 2-3% inflation over the business cycle. That means that, if output surges, the Reserve Bank (RBA) tightens policy; if output falls away, the RBA loosens policy. In other words, using the MV = Py equation, if y [output] surges, the RBA puts downward pressure on P [prices]; if y falls away, the RBA eases so that growth in P increases.

In other words, the RBA acts to stabiliise growth in Py (or GDP in money terms: i.e. NGDP). Which means it stabilises growth in spending, hence income (since income is just someone else's spending). Stable income growth means a higher transaction path.

Money is a transaction good. In Australia, monetary policy encourages stable growth in transactions. Monetary policy thus allows money to perform its function of being used in transactions, based on stable expectations of income growth.

The RBA does not treat minimising growth in P as the only thing to worry about. In particular, it does not play games with expectations; it does not suddenly shift its intended growth rate in P without telling folk, as the US Federal Reserve [Fed] disastrously did. Nor does it regard driving down income growth to keep growth in P low good policy, as the European Central Bank did, creating the European income, and thus debt, crisis. In Australia, money supply reacts to changes in money demand so as to keep stable growth in income by providing a stable framework for expectations about future income.

Which makes it a lot easier to keep public debt down, since income growth is relatively stable.

What is undermining European welfare states, particularly in Mediterranean economies, is a double "whammy". First, structural failures which restrict the ability to transact (and so the number of transactions); putting downward pressure on government revenue and upward pressure on expenditure. Second, monetary policy failure; so that preserving the "value" of the Euro is regarded as much more important than the level of its actual use in transactions. The mindset which declares the value of money is more important than its level of use.

To summarise the failure of European policy (and the failures of the Fed): it's transactions, stupid. And to summarise the success of Australian policy: it's transactions, of course.

Indeed, the greatest failures of Australian policy are in indigenous policy (with massive social failure in indigenous communities) and land use policy (creating way over-priced [pdf] housing). In both cases, restrictions on transacting are at the heart of the failure. Really, it's transactions, stupid.

Money inertia

This was originally provoked by a question and answer here.


The problem with the real price of money is that it is not real.

There is a view within economics – which was at one stage canonical – that money is an epiphenomenon; what matters is the “real price”, the price in terms of actual goods and services, and the “real economy”, the production, distribution, exchange and consumption of goods and services. (And assets, but we leave that aside.) To think that money mattered in its own right was to believe in the money illusion. As James Tobin wrote in 1972 (as quoted here [pdf]):

“An economic theorist can, of course, commit no greater crime than to assume money illusion”

Now it is obviously true that goods and services are what ultimately matters – we value money because we can buy goods and services with it and pay off obligations (to people who can then buy goods and services with it, and pay off obligations to people who can …: note that such obligations are typically implicit or explicit contracts – i.e. transactions operating across time). But if what matters is the “real price”, so that money is an epiphenomenon, the question then arises, why have money in the first place? What role is it playing?

To which the answer is: providing a huge reduction in transaction costs. What money provides is a universal transaction item. The more it does so, the more it is prized. It becomes the means by which transaction offers are made and accepted. It frames transaction offers and acceptances. It also frames obligations to pay. That is to say, its crucial value is being the medium of account (i.e., in Scott Sumner’s words, “the object that embodies the unit of account”).

For the alternative is barter, which is a much clumsier alternative: so much clumsier that even times of ludicrous hyperinflation, people still use money. What economists call ‘the real price’ is the barter price – the price in terms of goods and services. (Expressing this as ‘relative prices’ is another way of making this point, but one that continues to assume the use of money.) What economists call the ‘real price of money’ is its average barter price across all goods and services.

So, when I refer to ‘barter price’ I mean what economists call ‘real price’ as a barter price is a price in terms of goods and services and the real price is barter price expressed in a unit of account (typically money for a particular year) – a usage which in itself expresses the utility of money.

The real price of money is unknowable at the time of any given transaction. It can be (retrospectively) estimated, but that is all. If all prices were static for a known time period, so that the barter price for all goods and services relative to each other was known at the time of any given transaction, then any transferrable good or promise of service would do as payment, since its exchange value would be determinant for all parties. But money would still be used because it so reduces transaction costs (such as ease of movement and storage, allowing immediate transfer, economising on information and calculation, etc).
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Barter thus makes sense only when money is not available, or there is some strong penalty involved in using money sufficient to outweigh search and other costs involved in some specific barter or barters.

But all prices are not static for known time periods, so the real price of money is not knowable at the time of any given transaction. This means that prices and contracts will be in nominal values, because nominal values are specific, numeric (so can be added, subtracted, divided, multiplied, etc), applicable across goods and services and knowable. In that sense, nominal prices are real (in the sense of being knowable), and the “real” price (in terms of aggregation across all goods and services, or even just across one’s own budget set) is not. (The real price is not even numeric in quite the same sense, since it can easily involve odd fractions.)

Which means money can have real effects, because of the information lag between shifts in (nominal) supply and demand for money and overall price effects (i.e. shifts in the overall barter price of money). People will act according to nominal shifts because that is what they have immediate information on and it is what their prices, wages, contracts and obligations are specified in (money being the medium of account.) As the universal transaction item with a clear nominal value but a not-immediately-knowable overall barter price, money is not an epiphenomenon.

Moreover, as people tend to be loss averse (since people build up expectations and obligations based on existing income and wealth), and part of what is unknowable is how quickly other people’s prices will adjust to shifts in the real price, deflationary shocks (falling nominal prices, so rising barter prices for money) will tend to have more nominal stickiness than inflationary ones (rising nominal prices, so falling barter prices for money). This asymmetry in responsiveness (noted in a series of experiment here) is because raising one’s nominal price(s) is clearly compatible with being able to cover existing nominal prices, contracts and obligations. Lowering one’s nominal price is rather less so. Indeed, if it is known that certain prices, contracts and obligations will be slow to adjust or have already been set in nominal terms (such as, for example, tax obligations), then that effect is reinforced.

Remembering that, with regard to money, we are also dealing with powerful cognitive habits: which themselves are rational responses to the time and effort engaged in cognition and gathering information. Moreover, revealed rationality (rationality in behaviour) can easily vary from expressed justification. You do things because they work: one will not necessarily recall later all the considerations which led you to undertake an action, develop a habit, etc.

In particular, the slower one’s general cognitive responses and the more limited the relevant information available, the more dependant on cognitive habits and routines one will be. What people call ‘stupidity’ is often simple tardiness in responding to changed circumstances combined with some pertinent level of ignorance: hence the expression “x is slow on the uptake” and the importance of training to speed up responses (i.e. increasing the range and immediate availability of cognitive resources) to particular circumstances. So the higher the premium on cognitive economy (either in calculation or information), the greater will be the tendency to rely on nominal values.

Thus the term ‘money illusion’ is an illusion, because much of what is going on is not mere illusion, but (broadly) rational responses to information and other cognitive limitations as well as accrued obligations. It would be better to call it money inertia: the information lag to shifts in the overall barter price of money plus resistance to receiving less of the medium of account. Even when it is "pure" illusion, it is still a form of money inertia -- continuing to calculate in monetary terms rather than attempting to shift to (more complex) barter prices.

Why have contracts?

This was originally provoked by a question and answer here.


One of the most productive questions ever asked in economics is: “why do firms exist?” Why are not all economic agents sole traders? Alternatively, why is there not one big firm? Why, indeed, do firm structures vary so noticeably across industries?

The question was famously posed by Ronald Coase and he answered it with what became known as transaction costs. (A useful summary and appreciation of his work is here [pdf].) In effect, firms existed to minimise transaction costs: if it is cheaper to do a transaction in-house, then it is. If it is cheaper to do purchase a good or service externally, then it is. Firms are alternatives to coordination by the price mechanism. In a sense, they are areas of the suppression of the price mechanism. (Original article is here [pdf].) This was very productive question because it transformed organisational and institutional analysis -- many subsequent Nobel prices in economics were awarded for work based on use of transaction costs.

But is a firm defined by a transaction costs boundary? Or is it, as Yoram Barzel has argued, defined by the range of the guarantee of the equity capital? By the range across which expenditure to match obligations is guaranteed (and, if the guarantee fails, bankruptcy occurs). Firms then become mechanisms to deal with both risks and transaction costs. It is the intersection of comparative transactions costs and risk coverage that sets the boundary of the firm. Noting that it is existence of a realm where it is beneficial to replace the price mechanism (Coase’s point) that creates the range of expenditures needing the equity guarantee (as identified by Barzel) in the first place.

Coase’s analysis in itself does not explain why firm ownership is purchased and why the owner is the recipient of the residuum (the net income of the firm, whether positive or negative after all expenditures are paid for): adding Barzel’s analysis does. While Barzel's analysis does not identify why there is a range of transactions needing the equity guarantee in the first place (as Coase's analysis does.)

So, why do contracts exist? Why are not all transactions just on-the-spot swaps?

Lots of transactions are, after all. Not only are there spot markets, but retail markets are dominated by such on-the-spot swaps, where prices are free to move between transactions.
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Contracts exist for the same reasons firms exist, to lower transaction costs and manage risks. Contracts structure, and thereby permit, economic interactions that extend beyond a caveat emptor swap on the spot. A contract is any agreed transaction or series of transactions across time. So, any purchase which is not on a caveat emptor basis has some contractual element, as there is an obligation across time. (So even spot markets can have contractual elements.)

This is easiest to see with regard to labour markets. While spot markets for labour have existed, they tend to be relatively rare. Generally, people providing goods and services they do not make or provide themselves need to use labour with some regularity, and labour with specific skill sets and characteristics (such as reliability). A contract offers income to the provider of the labour on the basis of providing particular skill sets and personal characteristics. The promise of future income (to the labour provider) and future use (to the hirer of the labour) gives the hirer of the labour reason to engage in necessary training (even if only in the procedures of the firm) and a reasonable expectation of the labour being available. The hirer can then have a reasonable expectation of providing the goods or services he can then offer to customers.

The point can be extended to any good or service that is a regular part of the production process.

So, contracts exist to manage interactions across time. They are more than simply repeated games (such as one has with a regular customer/purveyor: though these can involve built-up expectations which can become implicit contracts). Contracts structure any interactions where there is a delay between provision and payment. So, ordering a meal in a restaurant is a contract, since you are promising to pay at the end of the meal. Even if payment for an on-the-spot swap is immediate, if a transaction is not caveat emptor there will be some continuing obligations about quality which make the transaction a contract.

In common law, a contract is a matter of offer and acceptance (i.e. mutual assent) and consideration. That is, a contract involves mutual agreement for some benefit (typically, an exchange of benefits). The mere matter of assent and benefit simply makes it a transaction: it is having explicit or implicit operation over time that makes it a contract.

Contracts reduce transaction costs – in particular, you do not have to keep searching for providers, negotiation costs are reduced (particularly if standard contracts, whether customary or statutory, are used) – and they reduce risks: you can act on the basis of reasonable expectations, with means of redress if there is a failure to provide as promised, making planning ahead easier. Since time-range transactions are so common, contracts are ubiquitous in human economies. So much so, that customary contracts evolve to an extent that people are not even conscious of being engaged in an (implicit) contract, as in purchasing a restaurant meal. By creating a structure one that allows transactions that operate across time (that is, loosen the time constraint) a contract also allows much more complex interactions than would otherwise be practical.

Having high levels of social trust and effective contract law enforcement greatly increases the range of transactions that it is reasonable to engage in. The biggest single economic advantage to high levels of social trust may well be the expanded ability to engage in contractual (i.e. time-range) transactions.

While there is some minimal trust element in on-the-spot swaps, there is so little that even black markets can engage in them easily. To engage in time-delay transactions generally requires an enforcement/recourse mechanism. This accounts for much of the overt menace in black markets, since such enforcement have to provided by the purveyor themself. (The rest of the menace and violence comes from the need to privately enforce property rights, making them much more “up for grabs”, and to deter assisting the state to enforce its ban of those transactions.)

So, a contract is a way of reducing transaction costs and managing risks thereby permitting transactions that have some element across time. Which leads rather naturally into the notion of a firm as a nexus of contracts.

Unlike firms, contracts are not generally suppressions of the price mechanism: typically, they are ways of extending its operation – that is, they bring a wider range of possible transactions into the market. What is distinctive about the contracts of a firm is that they provide the basis for alternatives to the price mechanism in coordination and their operation is within the guarantee of the equity capital. Noting that firms are a nexus of contracts does not, of itself, appear to add anything to the combined Coase-Barzel analysis of firms outlined above.

It is more that firms are a particular nexus of contracts. That is, firms and contracts are both ways of reducing transaction costs and managing risks: it is just that a firm uses contracts to create a specific realm of coordination and equity guarantee. Contracts are the mechanism, the firm is a particular conjunction of the use of contracts.

Housing bubbles and social mercantilism

A two-part essay on the problems of social division and failures of urban planning and management using Sydney and Melbourne as "compare and contrast" examples is here:

Since 1990, owner-occupied and investment property credit has expanded its share of total credit from 23 per cent to 58 per cent. (Business credit has dropped from 63 to 34 per cent.) Australians have been taking on large amounts of debt to invest in houses whose prices are largely a product of quantity controls: Australia has become a country highly leveraged on regulatory approval

and here:

Sydney’s land policy in particular is based on the social mercantilist model—with the inequality, conflict, inequity and corruption that model is inherently prone to. Melbourne can be thankful that its better social dynamics have ameliorated the ill-effects of the same disastrous ideas.

The author should have made it a bit clearer that you can have housing bubbles without quantity controls, they just make them more likely (and possibly more severe).

Why do the poor remain with us?

Norman Geras raises a point that recurs in his commentary in his excellent blog:

but what a mark against the world's wealthiest countries that there remains in them such a category of people - the poor - who can be spoken about in this way. These are societies fat, bulging, overflowing, with stuff; oozing personal wealth, economic crisis notwithstanding; and they are yet to provide all their citizens with a standard of material well-being such that no one would any longer need to be referred to as the poor but might enjoy, even as unequals, the advantage both of a more comfortable state and a more dignified style of description.

An obvious response is that, by the standards of history and of much of the globe, the people referred to as ‘the poor’ in developed democracies are not poor. [This point is made very powerfully via a graph here.] They have life expectancies, security of food and shelter and rates of possession of consumer durables that mark them out as among the blessed of history. Indeed, as Michael Cox and Richard Alm point out in their Myths Of Rich And Poor: Why We're Better Off Than We Think, poor people in the US in the mid-90s had an average level of possession of consumer durables that would have marked them off as middle class in the early 1970s. [This point is expressed graphically here.]

But, by the standards of their own societies, they are poor, even if poor means “middle class two or so decades ago”. So, why do we have a persistent category of people who lag behind the general prosperity?

Well, for no single reason. As Norman Geras intimates, it is not a matter of how productive the society is, as used to be the case when poverty was the general human condition. There have been sharp drops in the general level of poverty in Western societies over time. Which is another way of saying that developed societies have been great engines of mass prosperity: that is what makes them “developed societies”. But these drops in poverty rates slowed and then stopped: for example, the proportion of people in poverty in the US dropped steadily, even dramatically, during the postwar boom until the mid 1960s and has been stubbornly persistent ever since. Rather discouragingly, the apparent ending of mass exit from poverty coincided with increased government effort against war on poverty: the US “war on poverty” has been about as successful as the “war on drugs”. But similar patterns can be discerned in other developed societies.

Indeed, one way to put the question is “why has poverty persisted despite massive expansions in the welfare state?” The question is not often put like this, but it is a very reasonable question to ask, on the evidence. After all, the welfare state is a century or more old: the failure of eliminate poverty is a reasonable criteria to evaluate it by, particularly given its massive expansion from the 1960s onwards. (It can hardly be the fault of “capitalism”, as its success in generating unprecedented and steadily increasing mass prosperity is what has made the elimination of poverty a remotely plausible goal in the first place. Indeed, the first post-classical public welfare measures – Venetian public health measures, English poor law provisions – grew up in the most commercial societies in part precisely because they were the richest societies.)

One answer to the persistence of poverty might be: because of the expansion of the welfare state. After all, the great mass exits from poverty clearly were not products of the welfare state: they were the result of massive expansion in productive capacities. The welfare state needs clients: if there are no poor people, then there are no poor people to be clients. Milton Friedman pointed out that, if one took the entire expenditure on anti-poverty programs and divided it by the number of poor Americans, there would be no poor Americans. Clearly, employing people in secure jobs with good pensions in welfare bureaucracies, and the transferring of funds to people who are not poor, take up a considerable amount of welfare resources and generate a considerable number of beneficiaries: beneficiaries who might be of some risk of losing said benefits if poverty was abolished.

So, waste and failure in welfare might be one reason for the persistence of poverty. Particularly if such retards economic growth – given why the mass exits from poverty have occurred – by, for example, reducing the level of productive investment.

Or it might be due to welfare subsidising unfortunate patterns of behaviour. The richer the society, the less absolute the penalties for destructive behaviour patterns tend to be, but they still exist. One of the effects of welfare can be to soften the effects of folly (or, to be less blunt, lessen the penalty for patterns of behaviour not conducive to increased income). People can get away more with clinging to leisure preferences, instant gratification preferences or familiar attitudes and patterns of behaviour which are not conducive to good incomes. (And the behaviour of parents may well have effects on the prospects of their children.) If there is a bell-curve of income-producing behaviour, then there will always be a tail end. The richer the society, the better off the tail-end will tend to be. But they will still be the tail-end.

In the US, if one completes high school, get and stays married, get and stays employed (even starting at a minimum wage job) and avoids becoming involved in crime, one’s chances of staying poor are small.

We also get into some stubborn persistences here. Consider that, in the US, students of Asian ethnic backgrounds do far more homework, on average, than do black students. If lifetime income prospects are connected to educational achievement (as they are) and educational achievement is connected to student effort (as it is) then we can reasonably predict that poverty will be more common among black Americans than Asian-Americans on that one indicator alone (as it is).
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So, what can we do about this? If doing less homework leads to higher rates of poverty, does poverty lead to doing less homework? No, but the patterns of behaviour and outlooks which lead to poverty (for example, by discouraging scholastic effort) may do so. A society where human capital is important, and increasingly important, has limited ability to get specific groups to value the acquisition of human capital. But, if they fail to do so, they will have higher rates of poverty. So poverty will persist due to a failure to take advantages of the opportunities available (with some depressive effect on the general productivity of the society, since the level of human capital will be lower than it otherwise would be).

Moreover, how good is the welfare system likely to be at putting itself out of business by encouraging patterns of behaviour that lead to exiting from poverty? Noting that, to the extent that a social system can be said to have “an interest”, poverty is not in the interest of “capitalism” – there is far more profit to be made from selling to rich consumers than poor ones. More precisely, the logic of capitalism has clearly been to generate mass prosperity, since capitalism is the best system ever developed for creating and using capital (the produced means of production) and the more capital, the more production, the more prosperity, the less poverty.

The welfare system can also create barriers to exit from it. Public housing can “trap” people in high unemployment areas, as to move is to lose one’s eligibility. The very high effective marginal tax rates that beneficiaries face (from their benefits reducing, and taxes increasing, as they earn more money) also constitute a barrier to exiting from poverty. But such are expensive to fix and tend to keep the level of clients for the welfare system higher, so there is little incentive from within the system to push for reform.

There are also some forms of poverty that simply are not much of a concern. That university students have low incomes in their 20s is not a concern if they end up being high-earning professionals in their 40s. Indeed, as Cox and Alm point out, the increased participation in higher education is a major reason for increased income inequality – we can tell this, because the slope of “life cycle” income changes (i.e. average income by age group) has become much steeper than it used to be.

So, given the increased participation in higher education, something that also took off in the 1960s, some of the persistence in poverty is a life-cycle effect.

Some of the persistence of poverty is a “recent entry” effect. New migrants, lacking skills and entre into various networks, will tend to start off with low incomes. Increased low-skill migration will also tend to lead to persistence in poverty rates, particularly if there is an increase in the importance of human capital in an economy. It is likely that the children and grandchildren of new migrants will not live in poverty, but if the flow-in is constantly replenished, then the poor are being replenished.

And, of course, if migration to a developed democracy becomes a guarantee that one will not be poor, the incentive to migrate will be greatly increased. Milton Friedman famously argued that the welfare state was incompatible with open borders: certainly the welfare state is likely to increase the resentment of migrants if people believe they are paying for people whose arrival they had no say in.

The low-skill migrant point interconnects with the educational point. It is clear that the Anglosphere is better at attracting productive migrants than much of Europe (and, apparently, my own country of Australia is the very best at cherry-picking its migrants).

But that second-generation male Muslim migrants in Europe are “going backwards” in their economic participation points to another difficulty – barriers to economic participation. Some of these can arise from the behaviour of those with lower levels of economic participation (e.g. the lower levels of homework among black American students). Others can flow from regulation or other institutional factors.

Regulation has a persistent tendency to protect the interest of incumbents: this is particularly true in land use regulation and labour regulation: unfair dismissal laws, for example, protect incumbents against new entrants to labour markets (since they raise the risk of employing new people, particularly for small businesses). Faced with increased risks in employing new staff created by such regulations which is not compensated for by increased productivity, businesses respond by cutting back on hiring, relying more on certification and on “vouching for” networks, became more reluctant to deal with differences that might get in the way of communication (i.e. the transaction costs of cultural differences) and so on. If migrant Muslim males put less effort into school and so are less certificated, are more likely to “have attitude” (or are believed to be so), are less plugged into networks, have less skills then they will be disproportionately excluded by such regulation. Though young people generally suffer from such “protect incumbent” laws.

The problem of persistence of attitudes not conducive to exit from poverty are not only a matter for the poor, they can be attitudes among the better connected as well. Labour market regulation penalising the more marginal in the labour market, land use regulation driving up rents and housing prices by restricting the supply of land for housing are not created or justified by the poor, and certainly do not benefit them, but do disproportionately penalise them.

The capacity for “progressives” (or, as former Labor Senator John Black puts it [pdf] the inner city rich, the code word for which is apparently, ‘progressive’) to romanticise green fields (which are every bit as much human creations as any suburb, and may well have less biodiversity), thereby driving up the value of their inner city properties by restricting the supply of land able to be used for housing, and to frame labour market regulation as “protecting workers” (as, indeed it does: it protects incumbent workers against competition from marginal workers) does its bit to increase barriers to economic participation and so to the persistence of poverty.

Add all these factors together and the elimination of poverty – that is, of a category of “middle class minus two or so decades” – becomes difficult, to say the least.

So, is it a “mark against the world’s wealthiest countries”? Well yes, though not as much as it may seem at first blush and those who are most likely to hold it so are often very much part of the problem.

Or, to put it another way, the sort of mushy, self-satisfied reasoning that Norman Geras likes to berate Guardianistas for in international affairs has its domestic equivalents. There is even some suggestive social science research (pdf) that implies that conservatives signal competence while progressives signal trust: hence the importance to the latter of policy positions which allow one to signal one’s good intentions (and conservative contempt for any disastrous consequences, which the liberals deride as being unfeeling or otherwise lacking in virtue).

Indeed, we observe people who not that many years ago would have been nodding along to descriptions of science as a “patriarchal Western discourse”, not worthy of any privileging, now holding the results of climate science as absolutely authoritative: attitudes to science clearly being subordinated to the commitment to signalling virtuous intentions. But embracing of such serial, or even concurrent, contradiction actually improves the capacity to signal that one’s priority is membership of the club of the ostentatiously virtuous.

If we allow actions to have income consequences (since that promotes productive behaviour) but not negative ones (since that can lead to poverty), stop low-skill migration, ensure that the welfare system promotes independence and not dependence (even at the risk of losing its client base) but otherwise pays those who cannot be independent enough not to be poor, only permit students in higher education who won’t be on low incomes while they are studying and eliminate regulations and other institutional factors that are barriers to economic participation (which will require neutering the “progressive” intelligentsia having any effective capacity to frame public debate so as to block such changes), we in developed countries can have “tail ends” which are not poor by the standards of our societies.

Good luck with that.

Still, the good news is that we could do better: the bad news is that we probably won’t (beyond general increases in productivity).

About race

Commenter Fred, in response to my previous post, asked:

How would you respond to Steve Sailer's arguments about the existence (and relevance) of race (seen, for instance, here: http://www.vdare.com/sailer/presentation.htm).

Good question. Such a good question, I am repeating a slightly expanded version of my response as a new post.

As you would expect from Sailer, his presentation is the most intelligent presentation of the distinction I have seen. Except he makes no differentiation between race and ethnicity. Afghanistan, for example, is not a place of different races (in the modern sense) but of different ethnicities.

People form groups, but they then tend to seriously over-estimate the significance of the groups. Witness the ascription of characteristics to 'left' and 'right' or 'liberal' and 'conservative' by partisans of said groupings.

In some ways, the medievals were more clever about this. For them 'race' and 'tongue' meant much the same -- a person of my race was a person who spoke my language. Thus, I could communicate far more easily with, was likely to share a larger set of references, expectations, even preferences with them. (Afghanistan would be a place of different races to the medievals: but they had little experience with the continent-wide groupings we moderns call 'race'.) If one presumes differing capacity to communicate (i.e. takes a transaction cost analysis) one can explain most of the apparently "racial" patterns in modern societies, particularly in things like hiring and housing.

Skin colour and other physical features make easy "markers". But, as Sailer implies, not exactly precise ones. (Jew-haters have had terrible difficulty with that.) And ones which people have put widely different importance to over time. (The medievals put almost none at all, for example. They wanted to know your religion and your language: sensible folk, since they are likely to have real effects on behaviour.) The historical contingency of racial signification is something many of the "race does not exist" crowd are very aware of.

There are certainly genetic clumpings which have, for example, medical significance. (And sporting significance: folk of sub-Saharan African background rarely make champion swimmers because of natural buoyancy issues.) But race mainly matters because people think it matters and because language and culture do matter for interactions while language and culture have some (often, but not always, quite strong) association with ethnicity and thus race. But language and culture are a lot more plastic over time than ethnicity which is a lot more plastic over time than race. So, even conceding the sensible bits in Sailer, race is not what one should be concerned with for moral judgment, for public policy (outside some medical applications) and so on.

Discrimination as social cartel

This is based on a comment I made within a discussion group I am involved with.


In the matter of equal employment opportunity (EEO), being against quotas and extraneous paperwork is straightforward enough. Beyond that, we get into very difficult territory.

The Victorian Liberal Party, for example, has requirements for male and female officeholders throughout its entire structure. This was because politically organised women had numbers and money and insisted on the provision when the Liberal Party was being formed. They had had long, bitter experience of being used as activist fodder while being such out of decision-making and wanted to avoid that happening in the new Party. (Margaret Fitzherbert’s book Liberal Women is good on the history.)

There is also a long history of various exclusions: in effect, social “cartels” where signalling one’s “soundness” to fellow members means excluding certain “out” groups. Jews, Catholics, blacks, gays, etc have all suffered such exclusions.

One of the best antidotes to that is an open labour market. Unfair dismissal legislation in particular, by raising the risks of employing someone, works against marginal workers. The riskier hiring someone is, the more people compensate by lowering risk in other ways (relying on networks who act as information conduits and informal “guarantors”, requiring prior experience, certification, and so on), hence the strongly adverse effect on marginal workers. Thus France essentially shuts young Muslim men out of its labour markets by its protection of incumbent workers. While Sweden shuts many Somali refugees out of its labour markets by high minimum wages: Somalis do much better in Minnesota, for example, (see also internat’s comment here) which has much lower minimum wages.

Just to complicate matters, if people have varying degree of ability to communicate with different sets of people, that will affect (for example) hiring patterns in ways that are hard to disentangle from actual discrimination.

But it is demonstrably true that open labour markets are compatible with considerable patterns of discrimination: or, at least, systematic patterns of disadvantage that are hard to disentangle from outright discrimination. The productivity gain from hiring disapproved workers may well be sufficiently marginal/obscure that the status loss from doing so is enough to deter such hiring.

So, a complicated matter. Certainly not an argument against labour market reform and open labour markets. On the contrary, it is a strong argument for it. But also not an area where “but competition will stop discrimination” has historically proved to be enough on its own.

Of course, one could reasonably argue that nowadays the status loss is being seen to be so stupid and nasty as to be discriminatory in the first place.

On the other hand, being ostentatiously against discrimination is patently a way to gain status, which surely drives at least some anti-discrimination regulatory activism.

Institutions and the Path to the Modern Economy

While I am a tad critical at times of modern academe, it is also true that there is a great deal of enlightening scholarship being produced. Not all of which is, alas, terribly accessible.

Avner Greif’s Institutions and the Path to the Modern Economy: Lessons from Medieval Trade is a striking, but often rather densely theoretical, attempt to improve understanding by interweaving historical data with theoretical analysis. In particular, Greif seeks to inject time into analysis of institutions—that is, how they change from the actions of agents.

He looks at three sets of historical data: the Maghribi traders, a group of Jewish traders originally from Baghdad and then from the Maghreb who operated in the C11th and C12th centuries. The rise of the Hanseatic League. The rise and decline of medieval Genoa, Venice’s great rival.

Greif happily uses data from sociologists, anthropologists and social psychologists. Not clear to me that folk from other disciplines are as ready to use findings from economics (those well known evil believers in markets, private property and sceptics about government action). Greif, like his apparent mentor Douglass C North, regards Hayek as a serious thinker with genuine insights into the operation of knowledge and institutions: not an outlook I would expect in many areas of contemporary academe.

In looking at the different outcomes between Islam and Christendom, Greif suggests that the divine sanction of Sharia makes institutional change harder than it was for Christianity. Christianity grew up under Roman law and so (unlike Islam or Judaism) was comfortable with notion of man-made (and thus man-changeable) law.
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For example, traders within medieval Christendom developed community responsibility (if you have a grievance from one trader from a particular city, you could make your claim against any other trader from the same city). It was a way of transferring liability and operated as an intermediate means to overcome local (and partial) courts by creating local claimants. As time went on, the system generated increased trade that then, by sheer scale, undermined the system creating, Greif suggests, increased demand on kings and rulers to provide more effective court systems. The notion that demand for public goods helped direct the development of the state is an intriguing one. (It does depend on various forms of consent being important in political development.)

Islam lacked self-governing merchant cities and legal capacity for collective responsibility, so could not get through that intermediate step.

Greif’s case studies bring out that it is important to distinguish between beliefs that may guide policy actions and actual patterns of behaviour (which may not at all reflect such beliefs). Thus, just because official policy was often mercantilist, does not mean that traders behaved according to mercantilist beliefs.

I felt Greif’s take on the abolition of slavery was too simple (pp205-7), both in characterising it as being completely abolished and in suggesting that helped productivity growth. Slavery was not entirely abolished in Latin Christendom. And it was replaced by serfdom, which is another form of bondage. Moreover, Latin Christendom shows greater technological dynamism than Rome quite quickly. But his point that Sharia’ endorsement of slavery kept in going in the Muslim world much longer is certainly an arguable one.

Greif incorporates game theory into his analysis, in a nicely careful and considered way. I often found the most intriguing part of his case studies was his very intelligent characterisation of the choices and risks facing individuals. And how mechanisms evolved to deal with those problems—such as trader's agents being “overpaid” so to be self-policing. (Like modern corporations seem to do with their employees: supervision of effect on output is harder, so pay them more so they have more to lose.)

Greif argues that collectivist versus individualist cultural perspective changes relative costs in potential relationships: particularly choices between using kin networks versus non-kin institutions. (Falling importance of kin connections is something of a long-term trend in Western history.)

Greif is particularly interested in whether institutions are self-reinforcing or self-undermining. He argues that Genoa’s institutional solution to internal strife was less effective than Venice’s in generating reasons to identify with the wider polity rather than one’s own clan. So Venice avoided the civil strife that eventually hobbled Genoa.

The book is difficult going at times: much of theoretical sections I read lightly to get a sense, rather than trying to follow every logical step. I did, however, very much approve the use of empirical data to constantly check the developing theory. And the case studies I found highly informative. Greif makes the institutions of the medieval world and how and why they developed much clearer. (He has responded to a critique of his analysis of the use of reputation mechanisms among Jewish traders in the C11th.)