Institutions create wealth and improve standards of living by protecting private property. Investment in new businesses that create jobs and raise standards of living is risky enough in societies that protect private property. Without that protection, people will hoard their wealth by investing in land or gold, or they will send it out of country for safe keeping, as many people from Africa do who export their wealth to Europe and the U.S.
Historians, socialists, and journalists tend to confuse capitalism with business for profit. As a result they see capitalism existing everywhere and at all times in history. If that were true then capitalism would not have contributed to the hockey stick effect of world development because it would have always been with us. Capitalism as defined by Adam Smith and others requires specific institutions. Those include the rule of law, limited government, respect for private property, equality under the law and relatively honest police and judges.
What distinguishes the economy of one country from that of another? Each has access to the same technologies. All countries, even communist ones, have people who understand double-entry accounting. Every nation has large cities with banks and access to the world’s capital markets. They can train their people in the knowledge and skills necessary for any task. They have internal and external trade. In theory, every country could improve its productivity growth by adopting the appropriate technologies and management models, but most haven’t. Why? The answer resides in their institutions.
Dr. Alexander Kondonassis of the University of Oklahoma wrote in “Economic Development: Issues and Problems” that, “The institutional framework, i.e., system of values, economic, social and political institutions, exercises a critical influence on the productivity of the production input.” Institutions pose a serious problem for modern economics: they’re messy. Institutions make difficult variables to wedge into the mathematical models that dominate the discipline. Yet, Kondonassis contended that “a main reason for our deficient knowledge on economic development is that no adequate attention has been given to the non-economic aspects of development.”
Changes in technology and institutions are the deep wellsprings of development. The economic historian Cameron wrote in A Concise Economic History of the World the following:
The interrelationship of population, resources, and technology in the economy is conditioned by social institutions, including values and attitudes… A complete list of all the social institutions of relevance to the economy would cover many pages, and the analysis of their interactions with other relevant variables is the most frustrating aspect of the study of economic history. But any attempt to comprehend the nature and modalities of economic development without reference to them is foredoomed to failure.
Rigid institutions, characterized by the resistance of interest groups, create “obstacles to productivity growth because every economic improvement requires additional efforts to break down the barriers to change, which increases the costs of (or lowers the returns to) innovation,” according to Maarten Prak in Early Modern Capitalism. Examples of rigid institutions that have blocked, and continue to block technological innovation include guilds, unions, and common field farming. These institutions provided stability in highly volatile situations. But as the history of the Ottoman Empire in chapter 6 illustrates, inflexible institutions impede change and innovation.
One way that institutions affect productivity is through their impact on the supply of entrepreneurs and the freedom they have to act. Prak wrote, “The limits of entrepreneurial decision-making are dictated by the institutional framework of economic activity. In early modern Europe these limits were exceedingly narrow due to a high level of risk, the inadequate protection of property rights, and the rigidity of economic institutions.” But the most important way that institutions control productivity is in their protection of private property, or the lack of, according to Prak.
The creation of new technologies and ideas depends to a large extent on the protection of property rights. A dependable system of property rights guarantees investors a rate of return that reflects the social rate of return and thus encourages further innovation. Without sufficient protection private rates of return will fall short, creating a disincentive to investors.
North considers the inadequate protection of property rights the main reason for the slow rate of technological change in the pre-industrial era. The rate of progress accelerated from the late eighteenth century on, when substantial legal improvements raised private returns, and became sustained when market forces began to dominate the process of invention.
Private property rights require laws that define and protect property, enforce contracts, and prohibit theft and fraud. Other laws must restrict governments from taking property without compensation, appropriating surpluses through overbearing taxation, and taking control of property away from the owner through regulations and price controls. In addition, property rights demand courts and a police force that will enforce the laws untainted by corruption or favoritism as well as politicians with enough humility to accept limited government.
Institutions determine the rules of the game that in turn create the demand for particular types of knowledge and sets of skills. For example, using a sports analogy, the rules of soccer encourage the development of footwork and teamwork; golf emphasizes individualism; poker reinforces secrecy. The institutions that have existed throughout most of the history of mankind and still dominate the Third World, “overwhelmingly favor activities that promote redistributive rather than productive activity, that create monopolies rather than competitive conditions, and that restrict opportunities rather than expand them. They seldom induce investment in education that increases productivity,” wrote Douglass North in Institutions, Institutional Change and Economic Performance.
Nobel prize-winning economist Gunnar Myrdal, quoted in Michael Todaro’s Economic Development in the Third World, wrote, “Included among social institutions needing change are outmoded land tenure systems, social and economic monopolies, educational and religious structures, and systems of administration and planning. In the area of attitudes, the concept of ‘modern man’ embodies such ideals as efficiency, diligence, orderliness, punctuality, frugality, honesty, rationality, change-orientation, integrity and self-reliance, cooperation and willingness to take the long view.”
The military and political establishments that dominated the Ottoman Empire illustrate Myrdal’s point. Ottoman educational institutions trained students in skills necessary to succeed in the military and government bureaucracy. Meanwhile, those people involved in productive activities, such as farming and manufacturing lacked security for their property and had no incentive to invest or attempt innovations. In Russia, efforts to create a free market economy without the supporting institutions, especially protection for private property, allowed criminals to steal the most valuable resources of the nation. A more developed definition of capitalism should include the institutions that made the hockey stick effect in per capita income possible.
Bourgeois values
Many definitions of institutions include the values of the majority of people, but some see those values as so important as to need a separate category. McCloskey has pointed out the institutions of private property and the rule of law are necessary, but not sufficient to launch economic growth of the magnitude enjoyed by the West since 1800. The institutions so valuable to development existed in England centuries before the industrial revolution as well as elsewhere:
Legal developments in England that happened many centuries or many decades after (not to speak of their prevalence in China and Japan) cannot explain the exceptional applied innovations of northwestern Europe beginning in the late eighteenth century. Security of property was a very old story in the England of 1689, as it was in the Chinese or Ottoman empires at the same time. The depredations by the Stuarts were minor, if infuriating to the wealthier Londoners of a non-Conformist disposition. The merely prudential incentives to innovate were just as great
in the thirteenth century as in the eighteenth. Property rights, that is, were pretty full at both dates. Money was to be made. As Alan Macfarlane declared in 1978, “England was as ‘capitalist’ in 1250 as it was in 1550 or 1750.”
So institutions such as property are necessary for development, but are impotent unless the majority of people adopt the bourgeois values. McCloskey demonstrates that routine economics cannot explain the striking growth in northwestern Europe. Only rapid innovation can, but for a culture of innovation to surface along the North Atlantic coast, popular attitudes toward business had to change. “I claim here that the modern world was made by a new, faithful dignity accorded to the bourgeois – in assuming his proper place – and by a new, hopeful liberty – in venturing forth. To assume one’s place and to venture, the dignity and the liberty, were new in their rhetorics.” To help readers appreciate McCloskey’s thesis, he captures for the reader in The Bourgeois Dignity the extent of the debasement of commerce from ancient times.
People of business (declared aristocratic Plato and aristocratic-admiring Aristotle) are motivated by apeiros (unlimited) greed. Thus Aristotle in the Politics. The “no limit” in Aristotle is about buying low and selling high, which is supposed not to exhibit the diminishing returns that, say, agriculture does. In the thirteenth century St. Thomas Aquinas, referring to Aristotle with a little less than his customary enthusiasm for the Philosopher, retails the usual complaint against retailing, which depends on “the greed for gain, which knows no limit and tends to infinity.”
In the middle of the thirteenth century Thomas Aquinas had written in the style of his ancient and antibourgeois authorities, especially of Origen and St. Augustine and the desert fathers, and of Aristotle the teacher of aristocrats, that “trading, considered in itself, has a certain debasement attaching thereto, in so far as, by its very nature, it does not imply a virtuous or necessary end.”
Merchants in Japan and China ranked for three millennia close to night-soil men. In Christian Europe they were considered for two millennia the enemies of God. Innovations were long viewed as threats to employment. And so the best minds went into war or politics or religion or bureaucracy or poetry. Some still do, often on antibourgeois grounds taught to them by the clerisy after 1848.
In 44 BCE Cicero declared that “commerce, if on a small scale, is to be regarded as vulgar; but if large and rich...it is not so very discreditable...if the merchant...contented with his profits...betakes himself from the port itself to an estate in the country.” A merchant, said Cicero, lived by making the worse product seem the better, which was shameful (though an orator like himself, who earned the price of his tenement houses in central Rome and his country estate by making the worse legal case seem the better, was of course one of nature’s noblemen). In 1516 the blast by Thomas More – or, rather, by his character Raphael Hythloday (“peddler of nonsense”...) – can stand for the abuse directed for millennia at the vulgar traders and innovators of the towns: “They think up...all ways and means...of keeping what they have heaped up through underhanded deals, and then of taking advantage of the poor by buying their labor and toil as cheaply as possible...These depraved creatures, in their insatiable greed,...are still very far from the happiness of the Utopian commonwealth. [Where] once the use of money was abolished, and together with it all greed for it, what a mass of troubles was cut away!” The Earl of Leicester, sent by Elizabeth in the 1580’s to meddle in the politics of the already bourgeois Dutch, did not trouble to conceal his contempt for the “Sovereign Lords Miller and Cheeseman” with whom he had to deal. And even the commercial Dutch had a proverb, Een laugen is Koopmans welvaart, “A lie is a merchant’s prosperity.”
Imagine the anti-business assault from the left and popular culture, especially motion pictures such as Wall Street and the Wolf of Wall Street, multiplied by a factor of ten. That gives a taste of how much most people through all of history have hated businessmen. They held prostitutes in higher esteem. They blocked the despised Jews from participation in the “noble” pursuits of the military, government and the Church and forced them to earn a living in the most reviled ghetto – business. Then change happened, according to McCloskey in The Bourgeois Dignity.
An old class of town dwellers, formerly despised by the clergy and the aristocracy and the peasantry, began to acquire a more dignified standing, in the way people thought and talked about it, in European rhetoric about the middle-class activities. And along with a new dignity the bourgeoisie began to acquire a new liberty. Both were rhetorical events.
As the economist Deepak Lal put it recently, “Capitalism as an economic system [I would call it ‘innovation’] came about when the merchant and the entrepreneur finally were given social acceptance [‘dignity’] and protection from the predation of the state [‘liberty’].
If bourgeois dignity and liberty are not on the whole embraced by public opinion, in the face of the sneers by the clerisy and the machinations of special interests, the enrichment of the poor doesn’t happen, because innovation doesn’t. You achieve merely through a doctrine of compelled charity in taxation and redistribution the “sanctification of envy,” as the Christian economist the late Paul Heyne put it. The older suppliers win. Everyone else loses. You ask God to take out two of your neighbor’s eyes, or to kill you neighbor’s goat. You work at your grandfather’s job in the field or factory instead of going to university. You stick with the old ideas, and the old ferry company. You remain contentedly, or not so contentedly, at $3 a day, using the old design of sickle. You continue having to buy food for your kids at the liquor store at the corner of Cottage Grove and 79th Street. And most of us remain unspeakably poor and ignorant.
The shift in values to those of the bourgeois came together for the first time in European history in the Dutch Republic of the sixteenth century after it rebelled against Spain. Of course, the conception was not a miracle. Chapter 4 on “The Dark Ages” explains the historical development.
Zombie theories
The progress made in economic history and development economics over the past century has failed to slay many bad theories that attempt to explain the unique development of the West. Like zombies, the bad theories come back from the dead and have to be slain again and again. McCloskey takes on the zombie theories in his second book, The Bourgeois Dignity. For the most part McCloskey finds that the conventional wisdom on development fails to put forth a unique cause for the development of the West. Almost all of the features used to explain development in the West were present, often in greater abundance in the Ottoman Empire or China, elsewhere in the West or in the West at an earlier date, but did not spur development in those places or at those times. Development in the West was a unique event which requires a unique explanation, not an explanation shared with areas that did not develop.
Also, many theories of development in the West rely on a faulty view of human nature. They claim prudence as the sole motivation when in fact we know that humans are much more complex than that and let their religion guide them more than prudence. Or they treat people as animals who cannot plan, anticipate the future, or overcome obstacles but merely react to random events like beasts. McCloskey’s trophies of slain zombie theories include thrift, capital accumulation, greed, the Protestant ethic, colonialism, education, transportation, geography, energy, trade, slavery, exploitation, commercialization, genetics, institutions, and science. Here are brief summaries of some of his trophies:
Colonialism
Marx attributed the industrial revolution to “primitive accumulation,” by which he meant theft. In his theory, the revolution required massive amounts of capital to invest in the new factories and saintly savings could not provide it. He gave credit to the enclosure movement and the slave trade. Later writers look to colonialism, especially the theft of gold and silver from the Americas by Spain. But those cannot explain the West’s rapid growth:
After all, conquest, enslavement, robbery, murder – briefly, force – has characterize
d the sad annals of humankind since Cain and Abel. Why did not earlier and even more thorough expropriations cause an industrial revolution and a factor of sixteen or twenty or one hundred in a widened scope for the average European, or non-European?
Babylon, Greece, Rome, the Ottoman Empire and Spain all practiced “primitive accumulation.” Their capitals became the wealthiest in their day and the envy of the world by conquering others and stealing their wealth. But none sparked an industrial revolution because capital decays. Capital cannot be accumulated and held on to for centuries. The owners spend it on consumption so they must continually replenish it either through conquest or through the market. Entropy destroys capital in the form of buildings and equipment. All of the ancient empires succumbed to decay when they had extended their borders to the limit and could no longer conquer and steal the wealth to replenish what they had consumed. Besides, McCloskey shows that the cotton weavers who launched the industrial revolution in England had modest capital needs that were easily met through meager savings of family and friends supplemented with short term bank loans.
Some argue that colonization actually benefited the colonized. India endured centuries of colonization under the British, but Vishal Mangalwadi, an Indian intellectual, maintains that India would never have been able to develop institutions and a self-understanding capable of sustaining independence without the social, political, educational, and judicial reforms forced upon the subcontinent by the British in his book, India: The Grand Experiment. One could mention the thousands of miles of railroads, train stations, government buildings, dams, roads, schools and utilities built by the British, also.
God is a Capitalist Page 4