A Swipe at Douglass North and Institutional Economics

We're still on Bourgeois Dignity: Why Economics Can't Explain the Modern World. Here's one point where I think McCloskey goes too far, even if you can understand her reasons. She is bitterly critical of Douglass North, who I have talked about with some admiration on this blog. She believes North is still far too trapped within the Samnuelsonian rational-actor methodological cage.

The economists want the big change to be a matter of Northian "institutions" because they want incentive to be the main story of the Industrial Revolution and the modern world. But suppose incentive (Prudence Only) is not the main story, and cannot be the main story without paradox: if it was Prudence Only, then the Industrial Revolution would have happened earlier, or elsewhere. Suppose that other virtues and vices matter a lot-not only prudence, beloved of the Samuelsonians; but temperance, courage, justice, faith, hope, and love, which changed radically in their disposition during the seventeenth and eighteenth centuries.

So North does not take religion seriously, for example. And the approach has led to the excesses of agency theory in finance and corporate compensation. CEOs have to be incentivized and aligned - and paid as such - but the results have often been disastrous. Prudential incentives do not make up for the lack of other virtues. Instead,

A good deal of life and politics and exchange takes place in the damning of incentives and the assertion of meaning-the mother's love or the politician's integrity or the teacher's enthusiasm, what Keynes (and after him George Akerlof and Robert Shiller) called "animal spirits" and what Sen calls "commitment" and what I call "virtues and corresponding vices other than Prudence Only.

She insists that ideas and beliefs still matter.

I believe on the contrary, with Alexis de Tocqueville in 1853, that "institutions" such as laws are not fundamental: "I accord institutions," wrote Tocqueville in 1853, "only a secondary influence on the destiny of men.... Political societies are not what the laws make them, but what sentiments, beliefs, ideas, habits of the heart [in his famous phrase from Democracy in America], and the spirit of the men who form them prepare them in advance to be.... The sentiments, the ideas, the mores [moeurs] ... alone can lead to public prosperity and liberty."

I take the point, but not everything about rational-actor economics is wholly wrong. I've tended to take North as an example of thinking about people, rather than simply automatic equilibrium on the model of 19th century physics. It is not the whole story, of course. But it is a useful chapter. I agree with her general point that ideas matter. But I think we have to take motivation very seriously. Perhaps North has too narrow a view of motivation. But his work is still a step forward, which is more than you can say for much standard economics. It is about influencing human behavior, not simply laissez faire. He is asking the right questions, even if he is still restricted in methodology. And even then, his work is discursive rather than simply math. It isn't just "as-if" models. Still, perhaps I need to think a bit harder about the limits to North's approach. I might come back to this in due course.

Property rights don't explain the Great Leap

McCloskey is on stronger ground when she criticizes the specifics of the institutional explanation of the industrial revolution. It was not caused by better property rights, she says. Property rights had been relatively secure in England for centuries.

lack of defined property perhaps characterizes some parts of Europe during the ninth century (though consider the ordered realms of Charlemagne or Alfred the Great) but certainly not England in the seventeenth century, as North to the contrary claims….No quantitative case can be made, in short, that it was after 1689 that England moved from predation to security of property.

After all, if anything our existing property rights today are not necessarily stronger.

An American government armed with the doctrine of eminent domain and the power to tax incomes at combined federal and state proportions of 35 percent, and with administrative agencies having broad powers over labor relations and air pollution, not to speak of unusual definitions of torture and the ability to tap telephones, and a passionate desire to limit people's consumption of recreational drugs, seems in this respect to be more, not less, like the Muscovy of old than did, say, France in 1576.

Nor was there obviously better treatment of intellectual property rights or incentives to innovate:

A recent calculation by the ever-useful economist William Nordhaus reveals that nowadays an inventor gets a mere 2.2 percent of the economic gain from an invention: "Only a miniscule fraction of the social returns from technological advances over the 1948-2001 period was captured by producers, indicating that most of the benefits of technological change are passed on to consumers rather than captured by producers.

Innovation is not purely a matter of incentives. But that leads to the question: what does facilitate innovation? So far she says it is bourgeois dignity and liberty. But she has not explained why that should make such a huge difference.