ECONOMIC

HISTORY

TOPIC 1: THE BIG PICTURE

CLARK, G. [2007]; A Farewell to the Alms, (ch.1)

Before 1800 income per person varied across societies and epochs but there wasnt upward trends.
The Malthusian Trap ensured that short-term gains in income through technological advances were
inevitably lost through population growth.
The quality of life was not better than the ancestors; for example stature (a measure both for the
quality of diet and of childrens exposure to disease) was higher in Stone Age than in 1800.
What we can say is that, overall, average welfare declined from the Stone Age to 1800.

The Industrial Revolution changed forever the possibilities for material consumption. The richest
modern economies are now ten to twenty times wealthier than the 1800 average, even if its necessary
to underline that prosperity has not come to all societies.
Hence, we can say that Industrial Revolution reduced income inequalities within societies but it has
increased them between societies in a process called the Great Divergence. (gap in incomes between
countires = 50:1).

THE MALTHUSIAN TRAP: ECONOMIC LIFE TO 1800
The Reverend Thomas Robert Malthus, wrote An Essay on the Principle of Population in 1798.

This model is based on three assumptions, can be explained graphically and explains why
technological advance improved material living conditions only after 1800.

The crucial factor was the rate of technological advance. As long as technology improved
slowly, material conditions could not permanently improve. The rate of techonological
advance in Malthusian economies can be inferred from population growth.
War, violence, disorder, harvest failure, collapsed public infrastructures, bad sanitation, were
the friends of mankind before 1800 (and they reduced population pressure and increased
material living standard) as well as peace, stability, order, public health, transfers to the poor,
were the enemies of prosperity
The logic of malthusian model matches the empirical evidence for the preindustrial world.

The Malthusian logic also reveals the crucial importance of fertility control to material conditions
before 1800 also mortality was considered to be important and the Darwinian struggle that shaped
human nature did not end with the Neolothic Revolution but continued right up until the Industrial
Revolution.
Preindustrial England was a world of constant downward mobility; just as people were shaping
economies , the economony of the preindustrial era was shaping people. (at least in England, the
emergence of such an institutionally stable, capital-intensive economic system created a society that
rewarded middle-class values with reproductive success, generation after generation.)


THE INDUSTRIAL REVOLUTION

The stasis of the preindustrial world was shattered by two seemingly unprecedented events in
European society in the years 1760-1900:
1. The industrial revolution (repid economic growth fueled by increasing production efficiency)
2. Demographic transition (a decline in fertility which started with the upper classes and
gradually encompassed all of society and which allowed the efficency advance of the industrial
revolution to translate into the astonishing rise of income per person that we have seen since
1800).

The Industrial Revolution adn the associated demographic transition constitute the great questions of
economic history and therere three approaches that help us to understand the sistuation:

1. The industrial revolution is located in events outside the economic system, such as changes in
political institutions, in particular the introduction of modern democracies.
2. Preindustrial society was caught in a stable but stagnant economic equilibrium.
3. Industrial revolution was the product of a gradual evolution of social conditions in the
Malthusian era: growth was endogenous.

The conventional picture of the Industrial Revolution as a sudden fissure in economic life is not
sustainable infact theres good evidence that the productivity growth rate did not experience a clean
upward break in England hence when we try to connect advances in efficiency to the underlying rate
of accumulation of knowledge in England, the link turns out to depend on many accidental factors of
demand, trade and resources.
Why an Industrial Revolution in England? Englands advantages were the accidents of institutinal
stability and demography; in particular the extraordinary stability of England back to at least 1200, the
slow growth of english population between 1300 and 1760 and the extraordinary fecundity of the rich
and economically successful. The embedding of burgeois values into the culture, and perhaps even the
genetics, was the most advanced in England.

Whatever its cause, the Industrial Revolution has had profound social effects. As a result of two forces
(the nature of technological advance and the demographic transition) growth in capitalist economies
since the Industrial Revolution strongly promoted greater equality. Its important to underline the fact
that the greatest beneficiaries of the Industrial Revolution have been unskilled workers and the
redistribution of income toward unskilled labor has had profound social consequences.

THE GREAT DIVERGENCE
The question to which weve to answer is: how did we end up in a world where a minority of countries
has unprecedented riches while a significant group has seen declining incomes since the industrial
revolution? This disparity is reflected in ever-widening gaps in hourly labor costs across countries.
A detailed examination of the cotton industry, one of the few found from the earliest years in both rich
and poor countries, shows that the anatomy of the Great Divergence is complex and unexpected hence,
hardly to reconcile with economists favorite explanations. The technologies of the Industrial
Revolution could easily be transferred to most of the world, and the inputs for production obtained
cheaply across the globe but the thing that wasnt easy to replicate was the social environment and
one reason for it is the comparatively long histories of the various societies.
We should also take into consideration geography, botany and zoology since these disciplines are at
the basis of the selection mechanisms which can help explain how an initial advantage in establishing
settled agrarian societies in Europe, China and Japan, was translated into a persistent cultural
advantage in later economic competition. But another thing that we dont have to forget is that history
also teaches us that even within societies of the same tradition and history, there can be regions and
periods of econmic energy and regions and periods of economic torpor. This variations in the
economic vitality of societies existed across the malthusian era and they continue to exist this day. But
in the malthusian era theeffects of these variations were dampened by the economic system.



THE RISE OF WEALTH AND THE DECLINE OF ECONOMICS

Since the Industrial Revolution, weve entered a strange new world in which economic theory is of
little use in understanding differences in income across societies or the future income in any specific
society.
The final great surprise that economic history offersi s that material affluence, the decline in child
mortality, the extension of adut life spans, and reduced inequality have not made us any happier than
our hunter-gatherer forebears.
Within any society, the rich are happier than the poor but, as was first observed by Richard Easterlin
in 1974, rapidly rising incomes for everyone in the successful economies since 1950 have not
produced greater happiness. It is evident that our happiness depends not on our absolute weel-being
but instead on how were doing relative to our reference group. Thats why, despite the enormous
income gap between rich and poor societies today, reported happiness is only modestly lower in the
poorest societies.

PERSSON, K.G. [2010]; An economic history of Europe (introduction+ch.1)

INTRODUCTION: WHAT IS ECONOMIC HISTORY?

Economic history is concerned with how well mankind, over time, has used resources to create
wealth, food and shelter, bread and roses. Nature provides resources and man trasforms these
resources into goods and services to meet human needs. There are two kind of resources; renewable
ones and non-renewable ones but theres also labour that has to be considered as a resource and its
supply relies on how well mankind uses the other resources at hand.
The skills of labour, so-called human capital, were primarly based on learning by doing, and its only
since the nineteenth century that formal education has played an important role.
Efficiency is determined by the technology of production and by the institutions that give access to
the use of resources. Insitutions can be understood as the rule of the game for economic life.

Economic history traces the efficiency characteristics of institutions by studying the development of
commodity and labour markets, financial intermediaries, the legal framework of contract enforcement,
property rights, openess to trade and international capital flows.
Openess to trade and factor flows has varied dramatically throughout history; openess can increase
risk because open economies are more exposed to shocks originating in the world economy.

Technology is knowledge about how to use resources in the porduction of goods and services.

Material resources, such as capital equipment, land and natural resources, are what we can call rival
goods; it means that your use of a particular machine hinders others from its use. However, the factors
that generate efficiency, that is technology and institutions, are non-rival and it means that your set of

common knowledge to contruct a new efficient tool does not preclude others from using the same
knowledge.

CHAPTER 1: THE MAKING OF EUROPE
The formation of Europe was a long and historical process whihc involved political, cultural and
economic forces.
We delinate a nation or a union of nations by borders because borders represent the limit of political
authority and the capacity of the state to tax and spend on roads and public goods, such as defence and
law and order institutions.
The great historical paradox is that despite disruptive political forces, Europe remained as a unit of
cultural and institutional homogeneity because of strong cohesive forces, of which trade was the most
important.


The intensity of trade has been stimulated by the proximity and similarity of nations.
Economies come to share similar technologies and, as a consequence, similar income levels that will
also stimulate trade.

Empire building like that of the Romans tended to create homogeneity in language and law, there were
limits to the extension of the empire. We dont have to forget that since the empire had big dimensions,
the situation at the borders wasnt so easy; the commerce was not easy due to difference in languages
and/or currency and ita was often based on the barter and another important thing is that a such big
territory was not easy to control hence if the periohery was initially poor, it may remain poor because
it was left untouched by the knowledge, commodities and institutions that the trade brought (=
BORDER EFFECTS).
Border effects reduce trade and therefore maintain the lack of similarity between neighbouring
economies in the border areas.

Why would religions and cultural differences affect trade negatively? In the contex of long distance,
trade exporters and importers need to trust each other; different cultures, which also have diffeent
procedures for settling disputes, might discriminate against strangers.

On the other hand, similarity, proximity and the absence of (strong) border effects stimulates trade.

The Europe were talking about is an entity defined by cultural and institutional similarities; trade can
contribute to the breakdown of initial heterogeneity and maintain in these domains, but the formation
of the European Union in the latter half of the twentieth century is a new and historically unique
experience.

TOPIC 2: PRE-MODERN GROWTH

ALTER G. and G. CLARK [2010]: The demographic transition and human capital

In 1700 four features characterized all of Europe: high
fertility, modest educational attainment, the dominance of
physical over human capital and low rates of economic
growth.
By 1870 in much of Europe modern economic, fertility
levels had begun their decline to modern levels, education
levels were rising and human capital was becoming an
important income source.




THE PRE-INDUSTRIAL DEMOGRAPHIC REGIME
All European societies had high fertility in 1700 as well as high mortality hence population growth
rates remained modest (average population rate in Europe in 1700-1750 was 3.1%).
Talking about the fertility, weve to take into cosideration two important way of measure:
1. the GRR (gross reproduction rate) that is the average number of daughters born per woman
who lived through the full reproductive span (the average number of births was nearly six).
2. the NRR (net reproduction rate) that is the average number of daughters that would be born
though their lifetime by the average female born in each decade. (this rate fell much less
between the pre-industrial and modern eras).

The two authors think that is thanks to the Malthusian Trap that population growth rate was in line
with resources before the Industrial Revolution. In fact, the Malthusian Trap depends on three
assumptions:

1. the Birth Rate births per year per thousand persons, was contant or rising in real incomes
2. the Death Rate deaths per year per thousand persons, declined as material living standards
increased.
3. Material Living standards declined as population increased

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An implication of the Malthusian model is that the pre-industrial world, high fertility rates produced
high death rates, low life expectancies and low incomes. Hence a society coulf raise incomes and life
ecpectancy only through reducing the births at any given income.
A second implication is that high-income groups within a society would have higher net fertility.

FERTILITY LIMITATION WITHIN EUROPE
The European Marriage Pattern, is a curious mechanism that kept fertility in northwestern Europe
well below the biological possibilities and it has four features:
1. A late average age of the first marriage for women, typycally 24-26
2. High fertility within marriage
3. Many women, typically 10-25%, never married
4. Low illegitimacy rates, typically 3-4% of births.

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More than half of possible births were averted by this marriage pattern. The average woman
completed a third of her child bearing years before she married. Women who never married reduced
by a third to a half by the marriage pattern.

The situation didnt change a lot in 1870; the only important thing that its necessary to underline is
that this limitation turned out to be not as unique as once was thought in fact there were strong
fertility limitation alao in Japan and China.

It was thought that at least in the areas dominated by the European Marriage Pattern there was a
positive correlation between net fertility, income and education since the families with higher incomes
were the ones with more surviving children but this changed into a negative correlation after 1870.

THE MALTHUSIAN BALANCE IN EASTERN AND MEDITTERANEAN EUROPE
Earlier marriage increased fertility in eastern and Mediterranean Europe but mortality was higher
also, and life expectancy thus shorter.

THE EFFECTIVENESS OF MALTHUSIAN ADJUSTMENTS
Malthus described a world in which population adjusted to resources in ways that limited population
growth and returned real wages to a subsistence standard.
The strongest homeostatic mechanism was the decline in real wage when population rose (for Europe
the elasticity of real wages with respect to population size was about -1.6 = 10% increase in
population reduced real wage by 16%). high food prices in the wake of a harvest failure increased
death rates and reduced birth rates.

THE MALTHUSIAN REGIME IN DISEQUILIBRIUM, 1750-1870
Malthus published his description of the demographic system of pre-industrial Europe at exactly the
time when it ceased to exist in fact after 1720 mortality fell and there hadnt been epidemics strong
enough to raise mortality rates to earlier levels consequentely populations alla cross Europe expanded
rapidly (annual rate between 0.4 and 1.3%) and another important thing is that population growth did
not result in declining living standards (hence we can adfirm that the link between harvests and
mortality disappeared as incomes rose).

In the Russian empire and much of eastern Europe population growth must be explained in a different
way. Mortality, especially for infants, remained extremely high.

The French case is unique, in fact birth control became widespread at the end of the eighteenth
century, resulting in an early decline in birth rates; since decreasing fertility paralleled decreasing
mortality, French population growth rates were low.

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WHAT CAUSED THE MORTALITY DECLINE?
Thomas McKeown argued that better nutrition due to rising incomes was the main cause of the
mortality decline; in particular he argued that decreasing rates of airbone diseases cannot be
attributed to other explanations than improved resistence through better nutrition.

MEDICAL KNOWLEDGE: Its supposed that doctors could not effectively treat or prevent
disease before accepting the germ theory.
PUBLIC HEALTH MEASURES: environmental theories of disease created and interest in clean
water, closed sewers and better ventilation (many of the measures that were initially
successful in western Europe spread to eastern Europe)
EPIDEMIC CONTROLS: the biggest one was plague buti t was definetly destroyed in 1720
TRANSPORT IMPROVEMENTS
MARRIAGE: the Im , an index of the porportion married, showed the effect of the marriage on
fertility and the highest values were in the eastern Europe while the lowest were in the north-
western. To sum up: marriage was earlier in areas with more land per capia and marriage ages
were higher in industrial areas.
MIGRATION: with the simultaneous developments of the population growth and the Industrial
Revolution, the level of migration increased dramatically.

THE DEMOGRAPHIC TRANSITION

In the 1870s, birth rates began decreasing in most of western Europe. Some researchers noticed that
this fertility transition was related to geographic features.
Important were also the linguistic boundaries since they hindered the spread of ideas and infomration.
An important aspect of this situation was the fact that the people were willing to control family size in
fact the most common birth control method during the fertility transition was coitus interruptus.

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Family limitation was slower to develop where production was organized in labor-intensive family
units.

INCOME AND FERTILITY

By 1930 a strong, negative relationship between fertility and national income had developed; fertility
fell in every country but it fell most in the most developed countries.
Reasons:
Growing taste for luxury among wealthy women (such women were becoming too attracted
to parties, theaters and facy dress) = new products and new lifestyles in the growing
metropolitan societies created by the Industrial Revolution expanded choices.

In 1960, Becker proposed that children should be analized as consumer durables since they are
more like automobiles and refrigerators than like gasoline or food; the benifts derived from children
last a long time and parents don not need to purchase new ones as these benefits are consumed hence
parents prefer to invest in high quality rather than increasing the quantity of the family. He also
pointed out that raising children is a time-consuming activity and people switch their consumption
towards less time-intensive goods when incomes go up hence parents prefer to spend brief but intense
time with a small number of children.

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EDUCATION AND FERTILITY

Education can operate in two different ways in reducing fertility:
1. By changing parents desires and aspirations (Malthus himself wrote that education teaches
prudence and foresight and the desire to provide a better life for ones children)
2. By raising the costs of children.

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PERSSON, The nature and the extent of economic growth in the pre-industrial epoch, ch. 4

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Technological growth is present if we can produce more goods today than were produced yesterday.
Technological progress and division of labour enable the economy to have both positive population
growth and constant or increasing per capita income.
As long as positive population growth is increasing, aggregate demand (=income per heads * the
number of people) will be stimulated and hence, income per head.
The rate of technological progress can also be correlated with the level of population.

Growth in income per head is generated by the increasingly efficient use of greater resources, such as
capital and land. The capital/labour ratio did not change much in the pre-industrial period and the
land/labour ratio stagneted or fell. So increasing income will depend mainly on improved efficiency in
the use of the inputs in production. An approximate measure of these efficiency gains is so-called total
factor productivity (TFP).
Growth in TFP is routinely measured in modern economies and these measurements generate
estimates of national income, usually denoted Y.

TFP=INCREASE IN OUTPUT WEIGHTED INCREASE IN (LABOUR INPUT+CAPITAL INPUT+LAND INPUT)

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Persson adfirmed that labour productivity is identical to TFP only on the assumption that land and
capital per labourer are constant; if land per labourer declines over time then TFP is actually larger
than the estimate of labour productivity. In pre-industrial economies, we can assume that labour
productivity estimates are roughly similar to TFP estimates because land and capital per labourer do
not change much.
Hoffmans research suggested that variations in growth were very sensitive to social disorder.

Netherlands, which combined political independence with religious tolerance and a welcoming
attitude to immigrants with scarce skills, as well as growth- promoting institutions, became the first
modern economy.

A number of economic historians have used real wage data to infer income growth of productivity; if
real productivity increases, we should expect wages to increase.
In general, the developmentof real wages of urban workers, that is nominal wages defleated by the
price of consumer goods, gives a gloomy picture of the 17th and 18th centuries in Europe, apart from
the leading centres in the west.
National income is composed of wage income and income from capital hence we need to be careful
about interpreting changes in development of real wages as indicating changes in income per head,
because wages are affected by the distribution income and weve to remember that national income
per head in real terms can increase despite stagnating real wages, simply because rents and/or profits
increase.

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TOPIC 3: THE ROLE OF INSTITUTIONS:

GRIEF, A. [2006]; INSTITUTION AND THE PATH TO THE MODERN ECONOMY

Particular rules, beliefs, norms and organizations are central in order to define the INSTITUTIONS and
are the things that let us understand why institutions have such a profound impact on the behaviour.
Intertransactional linkages are central to INSTITUTIONS because, among other reasons, the
institutionalized beliefs and norms that motivate behaviour in a particular transaction reflect WHAT
other transactions were linked to it and in what way while ORGANIZATIONS are reflections OF and
means for linking transactions.

WHAT IS AN INSTITUTION?
An INSTITUTION is a system of social factors that conjointly generate a regularity of behaviour. Each
compoment of this system is social in being a man-made, nonphysical factor that is exogenous to each
individual whose behaviour it influences. Together these components (called insititutional elements)
motivate, enable, and guide individuals to follow one behaviour among the many that are
technologically feasible in social situations.
The institutional elements that generate and institution and that are taken into consideration are
rules, beliefs and norms as well as their manifestation as organizations.
A legal rule, a constitutional prevision, a moral code, or beliefs that do not influence behaviour are not
components of an institution.
To illustrate what an institution is according to this definition, consider a system of rules, beliefs, and
organizations that secures prosperty rights (= that generates the behaviour of respecting particular
rights). if the political processi s such that each individual cannot unilaterally alter the rules, the
rules are exogenous to each of them. These rules can be endogenous to all of them, as is arguably the
case in a democracy, or exogenous to most of them, as in the case under a dictatorship.
For rules to be part of an institution, individuals must be motivated to follow them hence behaviour
must be guided by rules and motivated by beliefs in legal sanctions (weve to underline that for these
beliefs to be possible, organizations constituting the legal system are required even if, we dont have to
forget that a court and a police force do not necessarily lead to the belief that infrangement will be
punished because many legal systems are corrupt or ineffective).

Since were also interested in the impact of the legal system, we must also examine the rules, beliefs,
and norms that generate behaviour among memebers of its constitute institutions. They have a dual
nature:
1. They are components of an institutions (with respect to the behaviour we seek to understand)
2. They constitute institutions (with respect to their memebrs behaviour).

Even if its true that legal sanctions provide motivation we dont have to forget the importance of
internalized beliefs that can generate a regularity of behaviour since by reflecting cognitive models

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about the structure of the world around us they also influence our way of acting. (ex. Prometheus
fire).

REGULARITY OF BEHAVIOUR
The regularity of behaviour means that theres a behaviour which is followed and its expected to be
followed in a given social situation by (most) individuals who occupy particular social positions.
Institutional analysis take into consideration regulrities that are robust, in the sense that they are
carried out in a broadly defined situation and this implies the fact that institutional analysis is
concerned with recurrent situations between the same individuals over timeor among different
individuals.
Social position specifies ones social identity which ca be defined by general factors or specific ones;
studying the behaviour of individuals occupying social position entails examing how their behaviour is
influenced by societal forces rather than individual characteristics.
For idiosyncratic reasons some individuals may hold private beliefs or have particular attributes that
lead them to act differently from others in their social position.
Its important to remember that the association of institutional analysis with the study of social
positions is common in sociology; Berger and Luckman argued that all institutionalized conduct
involves [social] roles. Another thing underlined by Giddens is that the degree of institutionalization
is the degree to which behaviour reflects social positions rather than personal characteristics.

MAN-MADE NONPHYSICAL FACTORS THAT INFLUENCE BEHAVIOUR
Institutional analysis is about sistuations in which more than one behaviour is physically and
technologically possible.
Man-made factors thet influence behaviour reflect intentional or unintentional human actions.
Theres a clear difference among the physycal man-made factors and the nonphysical ones and we
drive our attention to the nonphysical ones. We can notice that physical manifestations of non physical
factors have a secondary role in generating institutionalized behaviour; infact prisons themselves do

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not make up an effective legal system, rather corresponding rules, beliefs, and organizations are
needed to generate law-abiding behaviour.
For what concerns physical factors, technology and genetics also influence the set of feasible man-
made nonphysical factors: technology for monitoring workers enables the belief that shirking will be
penalized, genetic factors directly contribute to regulrities of behaviour in various ways.
Dont forget that theres tremendous variety across societies in the ways in which normtive behaviour
and social relationships are structured.

FACTORS EXOGENOUS TO EACH INDIVIDUAL WHOSE BEHAVIOUR THEY INFLUENCE
The object of study is further restricted by focusing on factors that are exogenous to each individual
whose behaviour they influence since factors that come under an individuals direct control do not
enable, guide or motivate his behaviour.
Institutionalized rules and beliefs are made yet exogenous to each individual whose behaviour they
influence since they are commonly known rules and beliefs in situation in which behaviour is not
technologically determined.
After being internalized, norms are beyond an individuals control.
We can sum up that institutional elements are social factors as they are man-made, non-physical
factors exogenous to each individual whose behaviour they influence. (this doesnt mean that
institutions are always exogenous to every individual.)
Its important to underline also the fact that theres an institutional hierachy and those higher up in
this hierarchy can be said to have the power over others. (ex. Legal rules and labor unions influence
decision made by the firms about the contracts and the employees have to respect the rules that are
part of the institution (=firm) that influence their behaviour.).
(Theres an important difference among a dictator and a prime minister because since its true that
both have the power of changing the legal rules, once these rules are institutionalized, the prime
ministeri s subject to them while the dictator isnt.).

INSTITUTIONS AS SYSTEMS OF RULES, BELIEFS, NORMS AND ORGANIZATIONS
Socially articulated and siddeminated rules create shared cognition, provide information, coordinate
behaviour, and indicate morally appropiate and socially acceptable behavior. Althought such rules can
reflect individualistic learning, they are usually socially articulated and disseminated and can take
many forms (formal or informal, implicit or explicit, tacit or well articulated).
Notice that rules correspond to behaviour only if people are motivated to follow them while beliefs
and norms motivate individuals to follow institutionalized rules.
Its useful to differentiate between two kinds of beliefs that motivate behaviour:
1. Internalized beliefs : are those regarding the structure and details of the world we experience
and the implied relationship between actions and outcomes. They reflect knowledge in the
form of cognitive (mental) models that individuals develop to explain and understand their
environment those are the beliefs that motivate behaviour at the individual level.
2. Behavioral beliefs (expectations) : they influence behaviour indirectly. Those are the beliefs
about the behaviour of others in various contingencies, whether or not the behaviour actually
occurs since an individuals beliefs about others behaviour directly influences his behavioral
choices.
Rules specify normative behaviour and provide a shared cognitive system, coordination and
information, whereas beleifs and norms provide the motivation to follow them.
Organizations have three interrelated rules:
1. To produce and disseminate rules
2. To perpetuate beliefs and norms
3. To influence the set of feasible behavioural beliefs

Example of the interrelated roles of various institutional elements:

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AN INTEGRATIVE APPROACH TO INSTITUTIONS
Rather than assuming that people follows rules, we need to explain why some rules are folled and
others are not.
Institutions are being defined as:
The rules of the game in a society (North, Ostrom, Knight, Weingast)
Formal or informal organizations (=social structures) (Granovetter, Nelson)
Beliefs about otherss behaviour or about the world around us and the relationship between
actions and outcome in it (Weber, Denzau and North, Grief, Calvert, Lal, Aoki)
Internalized norms of behaviour (Parsons, Ullmann-Margalit, Elster, Platteau)
Regularities of behaviour, or social practices that are regularly and continously repeated,
including contractual regularities expressing themselves in organizations such as firms
(Abercrombie, Hill and Turner, Berger, Schotter, Williamson, Young)

And the definition of institutions as systems of interrelated rules, beliefs, norms and organization each
of which is a man-made, nonphysical social factor encompasses all the above definitions.

Considering different definitions of institutions as mutually exclusive is counterproductive and it
curtails advancing institutional analysis.

A major fault line in institutional analysis separates those who adopt an agency perspective of
institutions (= individuals shape institutions to chieve their goals) from those who adopt a structural
perspective (= institutions trascend individual actors).

1. The agency perspective places the individual decison maker at the center of the analysis; it
studies institutions as reflecting the objectives of the individuals who established them. the
point of departure for such institutional analysis is at the micro level of the individuals whose
interactions in a particular environment give rise to an institution-
2. The structural perspective emphasizes that institutions shape rather than reflect the needs and
possibilities of those whose behaviour they influence. institutions structure human
interactions, mold individuals and constitute the social and cultural worlds in which they
interact hence the point of departure for such institutional analysis is therefore at the macro
level of the structure in which individuals interact.

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These two views must be bridged because each captures an important feature of the reality. Theres a
need to study institutions while combining the structural and agency perspective because institutions
influence behaviour while being man-made.

Economists have traditionally adopted the agency perspective but therere many economists that
prefer to use the structural perspective as sociologists do (they consider institutions as exogenous to
all individuals); therere also sociologists that follow Webers agency perspective to analyze the
institutions.

Other approaches to institutional analysis assert that institutions fulfill a particular function;
the major role of an institutions in a society is to reduce uncertainty (North)
institutions foster efficiency (Williamson and many others)
institutions are the means by which order is accomplished in a relationship in which potential
conflict threatens to undo or upset opportunities to realize mutual gains (Williamson)
the main function of institutions is to affect the distribution of gains (Knight)

Different approaches to the study of institutions rest on contradictory assertions about human nature:
individuals are capable of internalizing rules and that institutions are behavioral standards
that have been internalized (Parsons)
individuals are assumed to act opportunistically unless constrained by external forces
(Williamson)
institutions reflect humans limited cognition (Young and Aoki)
individuals have a comprehensive knowledge of the environment within which they interact
(Williamson and Calvert)

As weve deeply underlined with all the definitions that weve given, the definition of institutions
neither depends on a particular assertion about whether motivation is provided by economic, moral,
social, or coercive means nor subjects the analysis to a particular analytical framework. A such
definition is useful for advancing institutional analysis because institutions fulfill a variety of functions,
emerge through various processes, influence behaviour in situations that are and are not cognitively
well understood and rely on different motivationl factors.

EXTERNAL EFFECTS AND TRANSACTIONS
Motivation provided by beliefs and norms exogenous to each individual whose behaviour they
influence is the linchpin of institutions, as it meditates between the environmen and behaviour but for
such beliefs to exists, someone must be able to take actions that directly affect the well-being of
individuals whose behaviour is generated by the associated institution from taking various actions.
The past, present or expected future actions of others that are of interest here are those which have
external effects: one persons action directly and unavoidably influences anothers. the one whose
behaviour is generated by the institution cannot choose whether to be exposed to the impact of other
peoples behaviour.
Saying that in any institution someones action must have an external effect implies that trasactions
are central to institutions.
A transaction is defined here as an action taken when an entity, such as a commodity, social attitude,
emotion, opinion, or information, is transferred from one social unit to another. The social units taken
into consideration can be individuals, organiztions or other entities that are considered actors by
those whose behaviour we study. Transactions can be economic, political or social and can involve
inflicting pain or sharing emotions.
A necessary condition for ones behaviour to be influenced by man-made nonphysical factors
exogenous to him is that something reflecting someone elses behaviour was, is or is expected to be
transferred to him. instutionalized internalized beliefs and norms reflect transactions.
A transaction is defined auxiliary when it facilitates the generation of beliefs about behaviour
in yet another trasaction.
A trasaction is defined central when an institution generates behaviour in a transaction.

25

 A trasaction is defined potential when were dealing with actions that can be taken to transfer
an entity between individuals, thereby directly affecting the well-being or information of at
least one of them.

INTERTRANSACTIONAL LINKAGES, INSTITUTIONS AND ORGANIZATIONS
The behavioural beliefs which are possible in central trasaction depend on the beliefs and norms that
create intertransactional linkages. Institutionalized beliefs and norms, which directly generate
behaviour in central transactions, reflect the particular transactions that have been linked in a society.
Also auxiliary transactions are important since their interactions generate institutional elements.
Organizations can be defined as the arenas in which actions in auxiliary transactions take place.
organizations fulsill multiple roles among which, they influence the set of feasible beliefs in the central
trasactions. organizations are a manifestation of and a means for intertrasactional linkages and
thereby they alter the set of possible behavioral beliefs in the central transactions hence they change
the set of instutionalized behavioural beliefs that can motivate behaviour in the central transaction.
Organizations that link the central transaction to other transactions extend the set of possible
behavioral beliefs in the central transaction beyond those possible though such bilateral and
intertemporal linkages.
Its now possible to clarify the fact that organizations are both components of instititions and
institutions.

Organizations are seen as:
1. The arenas for political rule making
2. Players in the political rule-making process (Arrow, Olson, North, Thelen)
3. Private responses to the incentives that institutions entail (Scott).

26

27

PERSSON, Institutions and growth, ch. 5

As we saw in the Griefs article, insitutions are the rules of the game; some are informal while others
needd co-ordinated action by lawmakers to get established.
Modern economic historians tend to explain institutions by pointing at their efficiency-enhancing
effects; welfare state institutions are explained by the way they resolve potential market failures in
private insurance and capital market.

If there wouldnt be institutions, we would often occur in a situation known as the tragedy of the
commons. This is a metaphor for the waste of resources that may occur if there are no restrictions on
the use of resources.
Once we acknowledge that institutions often have a specific effects on welfare and distribution of
income we need to dwell on the meaning of the efficiency concept we use. Economists tend to stick to

28

so-called Pareto-efficiciency but since institutional changed often involves distributional effects, we
find that concept limiting for historical analysis. Hence, when we talk about an efficiency-enhancing
institutional change, we will include any change which confers a net increase in welfare.

We dont have to think that an institution is efficient just because its persistent; however, institutions
can survuve because they serve the interests of social groups which happen to have the political power
to resist change.
The guilds were one persistent institution in European economic history but they were akso the
subject of conflicting interpretations; guilds were associations of producers in particular field which
restricted competition from ousiders and regulated entry into their porfession, took care of the
training of apprenticies, fixed prices and mainatained certain quality standards in poducts.

A well-articulated interpretation looks at guilds as efficient institutions in economic context
where markets were thin and they did not work efficiently. They were criticized because they
were seen as rent-seeking clubs which rigged prices and exploited consumers and delayed
technological progress. (origin of these critiques: early liberals such as Adam Smith. The
discussion about the fact that guilds delayed technological innovations will probably never end
and when Adam Smith attached guilds, they were loosing importance.).
There are dissenting voices suggesting that guilds solved inefficiencies in thin markets where
some agents had market or political power.

THE PECULIARITY OF INSTITUTIONAL EXPLANATIONS:
To generate legitimate consequence explanations in history and social sciences we need mechanisms
that guarantee that efficiency-improving institutions are selected and survive.
An analogy between natural selection and the competitive selection of markets may sometimes be
appropriate: for example, when explaining why some firms are run by owners of capital and others by
the suppliers of some essential input, as with producer-directed or co-operatives. However, we also
need to recognize that deliberate disgn of institutions is and has been practised in history.

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THE CHARACTERISTICS OF A MODERN ECONOMY
As weve already seen, the Dutch econom in the sixteenth and seventeenth centuries was nominated as
the first modern economy because it possessed all the institutional characteristics of a modern
economy: free access to efficiently functioning markets, advanced division of labour and government
that respected and enforced properties rights. Even if the Dutch economy was considered to be a
model by Adam Smith and many others among the enlightened in Europe, it demonstrated that the
right institutions are necessary but not sufficient conditions for sustained growth.
By the early nineteenth century, the model economy was Britan which not only borrow what was
considered progressive from the Dutch but shared with it another institutional characteristic
conducive to economic growth: contraints on the political executive.
[NB: uncertainty about future taxes and government privileges to some and barriers of entry into
economic activity for others affected investments negatively in those nations where parliaments did
not succeed in limiting the power of the monarchy-
Theres an interesting story that tells us that sustained economic growth is not compatible with
predatory cleptocratic givernement; in fact in the late sixteenth century, the northern part of the Low
Countries broke away and the Dutch Republic was found while the southern part remained under
Spanish rule with its oppressive political and religious structures. The Dutch Republic prospered while
the initially richer south, lost many of its most talented merchants and bankers.

MARKET PERFORMANCE IN HISTORY
Markets are rarely perfect and the performance of markets has varied in history. One of the major
porblems with attaining market efficiency is the fact that information about goods and services is
difficult to get and costly to process. The price is supposed to summarize all relevant information
about a good, but economics do not tell much about how prices are actually set.
Since prices may be subject to a change in the import costs, there was a law, named the law of one
price, that adfirm that one price conditioned prices so that there was convergence to a price gap which
was equal to the transport cost. But this process was very slow before the introduction of an efficient
postal system hence important was the introduction of the telegraph in 1850s in Europe, 1860s in the
world and in 1870s Copenhagen was connected with Chicago.
Have markets become more efficient over time? Its not that easy to find a suitable answer to this
question but efficient markets need many partecipants and a cheap, fast and reliable flow of
information hence in that respect, the conditions for market efficicency, have improved considerably
and irreversibly. The major changes in this respect occurred in the first era of globalization in the
second half of the nineteenth centurywith the introduction of the telegraph and the commercial press.
A postal system with regular dispatches of commercial information developed from the beginning of
the seventeenth century. On the negative side, economies of scale are more pronuncied in the modern
economy, so that firms have become larger and larger over time. To conclude, market efficiency has
historically been impeded by slow and unreliable information.

THE EVOLUTION OF LABOUR MARKETS: THE RISE AND DECLINE OF SERFDOM
Serfdom in Europe is one example of a long-lived institution without apparent efficiency-enanching
characteristics. Serfs and their offsprings were heavily dependent on their landlord. Serfdom typically
developed in historical contexts of labour shortage such as the period after the population decline
following the demise of the Roman Empire.
Landlords needed to restrict the mobility of workers in order to make their profits higher, and that is
exactly what serfom is about. The peasant or farm worker was tied to the landloards estate and could
not exert the bargaining power inherent in a right to move and seek work elsewhere.
Therere several reasons why serfdom and un-free labour was not an efficient use of labour: these
reasons have to do with shirking and high monitoring costs.
E. Domar, an economist, told that when population growth picked up and continued into second
millennium, land shortage forced free labour to cultivate less fertile frontier land. That meant that the
peasants opportunity income fell, eventually to or below the wage offered by landlords. Now
landlords could negotiate with free peasants and obtain a positive land rent. In this process, peasants
were liberated from their bonds of serfdom and gained customary rights to the land they tilled and for

30

which they paid a rent to landlords instead of perfomring labour services. Althrough this process was
well on its way before the Black Death, the ensuring labour shortage triggered off a wave of second-
serfdom in some parts, particularly in eastern Europe.
Most of Western Europe entered the Early Modern period with reasonably efficient labour and land
markets for sale and lease, followed the emancipation of the pesantry Denmark and Bohemia, later in
Prussia and even later in Russia. Weve also to underline the fact that the end of serfdom in Britain was
a spontaneous market-led process, while the late emancipations were initiated by reform-minded
elites inspired by liberal ideology. This suggests a specific and widespread form of institutionl change:
IMITATION of institutions which were judged to function well in other and more successful
economies.

FIRMS AND FARMS
As a consequence of agricultural reforms the relative importance of the household-based farm
increased while the big estates fell back. Its important to point out that the share of estate production
in total agricultural production has often been exaggerated because the estates were the only
producers which kept records.

31

Consolidated farms run by households are an eighteenth and nineteenth century phenomenon in
Western Europe. Before the concentration of landholdings in single large plots, so-called open field
agriculture prevailed in major parts of Europe, in which a household owned or leased land scattered in
a large number of narrow strips around the village.
The open field layout allowed or forced farmers to co-operate in ploughing, sowing, weeding and
harvesting. Historians have been puzzled by the endurance of of this seemingly impractical system of
harving small plots of land scattered over a large area.
The economic historian D.McCloskey suggested that by having its land scattered over the entire village
the household minimized risks associated with local harvest shocks that could materialize if all land
was concentrated in one location.
Others have noticed that small communities, such as farming village, were built on mutual assistance,
and the co-operation enforced by the field layout enabled memebers to monitor the efforts of the
others in order to maximize the output of all.
As farming household were abandoning open field agriculture, sometimes forced to by ambitious and
modernizing reformers, and consolidated their farms, manufacturing firms broke away from small-
scale production.
The reason for which only in agriculture the producing unit or institution remained linked to
household while in another industry units were becoming larger can be found in the fact that in
agriculture, the residual claimant (that is the one that receives the remaining income if any, when all
expenses including rents have been met.) was owned by the peasant household (that was also the
worker)while in industry workers do not own or hire capital bue theu were employed by the factory
owner at a fixed wage and the factory owner was the residual claimant.
Since natural accidents, both negative and positive, are likely to intervene between sowing and
harvesting and its difficult to disentangle the effects of labour efforts and of nature. Hence agricultural
workers will neither be fully rewarded for their effort nor be fully punished for shirking. Since
monitoring the activities of the workers was really difficult because economies of scale werent that
larger, landowners tend to lease or sell their land to farming households for which monitoring costs
are by definition zero.
For what concerns industry, monitoring work efforts is easier even because the quality of products is
routinely assessed and malpractice by workers can be detected fairly easily. Systems of reward and
control are not costs-free but economies of scale in industry are larger because thep production
process is constrained only by human ingenuity and not by nature, as agriculture is.
In early industrialization, the economies of scale stemmed from the need for a critical mass of fixed
investments; it would be possible to image a world in which workers borrowed capital to set up
labour-managed firms but that has rarely happened also because the capital markets were poorly
developed and imperfect in the first phase of industrialization.
Its important to point out that modern researches on the few examples of labour-managed firms,
showed up that such firms faced credit constraints which are more binding than those facing capitalist
firms. Furthermore, managing firms is inherently risky and the rich can endure risk better than the
poor and, as a consequence, the high risk exposure might discourage the formation of such firms. Its
exactly in this situation that we can talk about path dependence: a particular institution need not be
the most efficient; it only needs to be sufficiently efficient to become established, once established i t
will breed its own success and even exclude alternatives that are more efficient.

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CO-OPERATIVES AND HOLD-UP
In many areas the dominance of capitalist firms, that is firms managed by (representatives of) owners
who were residual claimants, was challenged in the late nineteenth century by co-operatives firm,
managed by (representatives of) the suppliers of a major inout processed by the firms (ex.: diary co-
operatives in Scandinavia owned by farmers) .
Co-operatives prevail in some lines of production and not in others because theres different sources
of input and some of the suppliers involed may be able to exploit the hold-up power. When a firmi s
faced with suppliers who can exert hold-up pwer by refusing to supply agreed quantities according to
long-term contracts, it normally tries to integrate that supply chain within the firm: vertical
integration.
Vertical integration was not an option in the late nineteenth century agriculture, since there was a
multitude of independent farmers who had no interest in selling their property in order to become
farm workers. The co-operatives dairy firms explicitly faced the risk of opportunistic behaviour on the
part of the member-owners as well as the need for long term committments from the suppliers. A co-
operative diary was in fact a vertically integrated firm owned by the farmers who supplied the milk.
Memebers had to commit themselves to long-terms contracts but became the residual claimants. The
problem of opportunistic behaviour was solved by severe punishment for those who were detected
breaking quality requirements, and co-operatives used informants to monitor memebers behaviour.
Since memebers were the residual claimant, they had interest in reporting misconduct. A member
breaking the rules could be stripped of his membership rights, including the money he had invested in
the co-operative. In a capitalist diary firm the owner was the residual claimant and therefore suppliers
had no interest in monitoring and reporting the misconduct of other suppliers.

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CONTRACTS, RISKS AND CONTRACT ENFORCEMENT
Contracts more often than not developed spontaneously, and tend to reduce risk and contrain the
opportunistic behaviour of contracting parties.
In commerce, manufacturing and shipping, a way to reduce risk was partnership contracts.
Partnerships developed further with the need for long-term capital in the nineteenth century: the
limited liability model is an excellent example of an efficiency-enhancing institution.
Old-style partnerships could be associated with unlimited liability, which restricted the partnership to
people who trusted each other. In early industrialization, memebers of partnerships were therefore
often recruited from family and friends, which restricted the amount of capital that could be raised.
Credit co-operatives (a type pf savings bank which sprang up in rural areas in the nineteenth century)
also had unlimited liability among members; a member could be liable for default by other members,
and members therefore had to trust that others did not behave in an opportunistic way by exploiting
the trust of others in their own interest. Trust is seen as social capital and it has to be considered as a
self-enforcing unwritten contract.
Fixed-rent contracts and sharecroppin were the two most common forms.
However, even if were to believe that the share-contract was efficient for the contracting parties, it
was not an output-maximizing institution from a social point of view, since it was associated with
lower output than under the fixed-rent contract.

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ASYMMETRIC INFORMATION, REPUTATION AND SELF-ENFORCING CONTRACTS
If were taking into consideration long-distance trade, principal-agent problem, due to information
asymmetries, can occurr.
Grief studied a wide variety of contracts in medieval trade, when information travelled slowly and was
difficult to assess. Given the difficulty of monitoring appropiate behaviour in agents, an ideal contract
needed to be self-monitoring; should be in the agents own interest to be honest or the long-term gains
from honesty must be higher than the short-term gains from cheating. To secure that, reputation has
to matter. Therefore merchants joined forces, reported any misconduct by agents, and agreed not to
employ agents who had been discovered to behave dishonestly. Since agents knew that reputation
mattered for future employment, they had an interest in complying with agreed standards of
behaviour.

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PERSSON, Money, credit and banking, ch.7

THE ORIGINS OF MONEY
We know that one of the major cause of productivity increase in pre-industrial economies is the gains
from division of labour resulting from occupational diversification in an economy where regions and
nations expolit their comparative advantages. Money, as a means of exchange, developed alongside the
occupational and regional division of labour. The first money, five or six thousand years ago, consist of
standardized ingots of metal which were generally accepted as a means of payment. Chinese and
Greek civilizations introduced coins which were stamped like modern coins.
To understan the advantage of money, its woth looking at its historical antecedent and alternative:
The barter requires coincidence of wants between trading partners.
It was a time-cosnuming activity and it reduced also the volume of trade that is constrained by
the minimum trader (that is the one who decides the terms of the barter).
Another important characteristic of the barter is that the price pattern is not very trasparent
because prices are not expressed in a single unit of account.

The evolution of money is a fine illustration of how societies invent and develop instruments and
institutions that minimize transactions costs and risk, withe the consequence that trade and
specialization are stimulated as we can notice with the invention of money that solved the problem of
non-coincidents of wants.

Throughout most of history money can be characterized as commodity money, which means that
money has been made of commodities which have alternative uses and an instrinsic value. (ex: gold
and silver or pearls and shells).
To be widely accepted as a means of payment, money must be easy to recognize because it must serve
in daily transactions among strangers. Furthermore, the chosen commodity needs to have a high
value-to-weight ratio because otherwise it could not easily be stored or carried to and from the market
place. This is an important characteristic, which first eliminated copper as a monetary metal and
favoured silver and gold. Pre-industrial mint technologies were fairly rpimitive, which made it easy to
counterfeit money. Not until the nienteenth century did technologies develop conterfeit-prof coins.
Coins with an intrinsic value equal or close to their official denomination or face value precluded
counterfeiters from reaping sizeable profits. If counterfeiters tried to reduce the silver or gold content
or the fineness of the metals it would soon be detected. At major markets, there were moneychangers
who specialized in assaying the fineness of coins in circulation.

THE REVIVAL OF THE MONETARY SYSTEM IN EUROPE: COINS AND BILLS OF EXCHANGE
With the decline of the Roman Empire, Europe lost an orderly monetary system. The revival came with
the Carolingian Empire, which introduced the principle of hierachy of denominations that had a lasting
impact on European monies and survived in Britain into the 1970s, when the decimal system was
introduced. A pound of silver was divided into 240 pennies (denarii), each containing approximately

36

1.7gr of silver, and later a dozen pennies were called a shilling or sou (solidus); 20 shillings
consequentely made a pound (libra). The penny was, for a long time, the only coin stuck. But the mint
levied a fee when it was striking coins, often around 5-10% of the face value of the coin, the signiorage
fee. That fee covered the actual minting cost but was also a way to raise income for the government.
However, governements found it tempting to fund expenditure by debasing the coin, that is by
lowering the gold or silver fineness of the coin but in the end, the practice created trouble because it
would drive good money, that is full-bodied coins, out of circulation and eventually start and
inflationary process.
The period of centralized minting did not survive the Carolingian Empire, and very soon cities and
monasteries assumed the right to mint coins and the silver content varied a great deal across regions.
As time passed, new denominations were minted which were multiples of the penny.
Money is the most useful in local spot exchange of commodities. International or inter-regional trade
required a more sophisticated means of payment because carrying specie, that is gold or silver coins,
from trading post to trading post was was both dangerous (due to the risk of theft) and cumbersome.
In the course of the medieval and early modern periods, a series of financial innovations minimized
the use of commodity money as a means of payment but at the same time kept money as a store of
value and a unit of account. These innovations also introduced credit. Exporters might need payment
at the time of shipping the goods while the importer wanted to defer the payment until the goods had
arrived and culd be inspected and sold. The instrument that gained acceptance and widespread use
from the thirteenth or fourteenth century and dominated international payments until the early
twentieth century, was the bill of exchange, which minimized the actual transfer of coins or buillon
between trading parties. The bill of exchange is essentially a promise from the debtor to pay the
creditor at a specified point in the future.
The essential impact of bills of exchange was to permit the flow of goods while still minimizing the
costly and risky business of shipping precious metal money. Institutions developed so that debts and
credits could be offset between accounts held by merchants through simple bookkeping transfers in
the ledgers of banks. These operations depended on moneychangers and banks having opened up for
deposits and clearing between different account-holders.
The early development of the bill of exchange was initiated by italian merchant bankers, and it spread
throughout Europe thank to italian migration to the major ports along Europes Atlantic coast. The
Hanseatic League only later learned about the use of the bill of exchange.
Although initially emerging as an instrument facilitating trade, the bill of exchange over time
increasingly became a financial credit instrument and a substitute for money.
Since the bill is essentially an obligation for a debtor to pay the creditor a given sum at a given future
date, it can be a very risky instrument hence most trading cities had legal procedures to force debtors
to honour their obligations.
However, there were a number of legal hurdles involved in increasing the transferability or
negotiability of a bill, which were sorted out during the fifteenth and sixteenth centuries. Each person
who took part in the chain of transfers of a bill had to be responsible for ensuring that promise to pay
the debt was honoured when the bill matured. As a consequence, a bill could be used in a chain of
commercial transactions and it also became a liquid asset for many banks, because it could be re-sold
if the bank needed cash. Deposit banks accumulated liabilities to their depositors, but held only part of
the deposits as reserves and invested the remainder in profitable assets or loans to the public. That
was the birth of the practice of modern commercial banking, the so-called fractional reserve bank,
which was established in Italy around the fourteenth century and spread to other commercial centres
in Europe. Weve to remember that the history of early banking was one of recurrent bankruptcies
because banks tended to hold too small a share of their deposits as reserves and because banking
involves the monitoring of borrowers whose commercial success is difficult to assess. Banks were
therefore vulnerable to banks runs, when people demanded their deposits in cash because of rumors
of insolvency.
By the end of the nineteenth century the development of the deposit banking system with branch
offices changed the role of the bill, first in the domestic and international trade.

USURY AND INTEREST RATES IN THE LONG RUN

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Banks charge borrowers interest and pay it to depositors. However, interest was long under critical
scrutiny from both Church and political authorities; the Church adopted a more flexible stance when
trade an economic activity increased the demand for and use of credit. A reasonable interpretation of
the usury prohibition is that it was directed against creditors who exploited people in need, permitting
lenders to charge high interest rates, often above 50 and sometimes bove 100% on a yearly basis.
Political authorities supported the fundation of public pawnshops which charged much lower interest
rates. These pawshops (the montes pietatis) had also a philanthropic aim and were widespread in
medieval Italy. Pawnshops did not make commercial loans and were mainly used by the common
people for short-term credit to ease temporary economic hardship. The Church interpreted the
interest rate as a payment for the costs the pawnbroker incurred for storage of the commodities which
the borrowers deposited in the pawnshop. Not all types of interest were considered as usury infact a
borrower who was not paying back the loan could be charged a fee for not honouring the letter of the
loan conract. Sometimes that fee was agreed on in advance but, more importantly is the fact that the
opportunity cost of money lent became the legitimate ground for an interest rate.
We should point out that Reformed Churces retreated from the role of arbiter and accepted that
secular authorities should be given the role of regulating interest rates. Its unclear what effect, if any,
prohibition of usury had on interest-rate levels. However, over time interest rates have tended to
decline. Commercial loans often had interest rates in the range of 10-20 per cent in the twelth to
fourteenth centuries, but they fell to single-digit levels thereafter, down to 5% or lower in the
eighteenth and nineteenth centuries. This implies that real interest rate were a slow in the nineteenth
as in the twentieth century.

THE EMERGENCE OF PAPER MONEY
The next decisive step in the evolution of an efficient means of payment was the emergence of paper
money which were easier to carry around than coins for cash transactions and cheaper to produce.
Paper money can be considered as a mutation of the bill of exchange which reduced the risk and
transaction costs involved in making the bill transferable and negotiable by written endorsments. The
only thing that mattered in this process was the reputation of the bank that issued the note; if the
public trusted the bank they accepted the note as a means of payment. The forst two centuries of
paper money kept a link to commodity money in which notes could be converted, on demand, to full-
bodied coins. Since the first note-issuing banks were profit-maximizing and the average customer did
not have full information on their solvency, banks were forbitten in many nations to issue notes with
low denominations.
The entitlement to exchange notes for gold or gold coins did not disappear until the interwar period of
the twentieth century, by that time the private note-issuing banks had been replaced by public central
banks with a monopoly on the issue of notes.
Initially paper money developed spontaneously; if a merchant deposited gold or coins with a
goldsmith or moneychanger the receipt could be used as a means of payment, so that receipts could go
from hand to hand as long as the public trusted the issuer of the receipt. This can be seen as a non-
standardized form of banknote, and such receipts circulated long before standardized notes gained
widespread acceptance in the eighteenth century. The receipts were taking into consideration were
pieces of paper which were redeemable (convertible to gold or full-bodied coins) and to accept them
you had to have confidence that the institution that had issued the receipt would honour its promise to
convert paper to gold.
The first banknote was issued by the Swedish Bank Stockholms Banco which founder had Dutch
origins. Stockholms Banco was a deposit bank which also lent money to the public. The loans and
deposit receipts were issued in banknotes, which were claims on the bank. The banknotes were easier
to be used rather than the heavy copper plates used in Sweden at that time, but the public lost
confidence in the banks ability to honour all its outstanding liabilities and a tun on the bank ended its
short history (1657-1668).
England became the pioneer in developing note-issuing banks during the 1690s and into the
eighteenth century; banks offered deposit facilities, discounting, clearing and note-issuing. Note-
issuing bank practised fractional reserves banking which means that the deposits they held as
reserves were only a fraction of their total note issue. Thereby banks contributed to the
monetanization of the economy as they increased the money supply. Theres a virtuous circle in the

38

development of banknotes in the sense that the more people use notes, the grater will be the
advantages of using them, since they reduce costs.
The kind of money taken into consideration was called fiat money and this non-convertible kind of
pape money was used for shorts period during crises but it only emerged in a orderly fashion after the
final break-up of the international gold standard in the 1930s.
Fiat money was accepted slowly because it required trust on the part of the public that the issuers will
not be tempted to issue too many notes, which would fuel inflation and erode the purchasing power of
money.
Convertibility of bankonotes to specie was an assurance to the public that paper was good as gold. In
the eighteenth and nineteenth centuries, when private banks were issuring their own notes, a bank
which was not prudent enough would see its notes fall in value relative to their face value; those
defending free banking, that is a system without a central bank, believed that non-prudent banks
would be abandoned by their customers and that would eventually discipline all banks.
In the world of finance, the default of one bank will have a contagious effect on the entire banking
system and the reason is that customers, the depositors, are victims of the phenomenon of asymmetric
information hence its diffuclt for them to judge whether a problem which is fully revealed in one bank
is an isolated phenomenon or a sign of a general distress, and they will withdraw their money as a
precautionary move. Given this situation, it was in the interest of all banks to establish some
supervisionary agency, together with a lender of last resort mechanism to prevent defaults and the
contagious effects of defaults. Since this agency was made up by banks, it was difficult to guarantee its
impartiality because the memebrs were also competitors. The lender of last resort mechanism was
also difficult to handle by an union of banks if they were all threatened by financial stress.
However, the public had every reason to be sospicious about central banks as well. If a government
exerted control over its central bank, as most did initially, there was a risk that the government would
ask the bank to lend freely to the government, that would fuel inflation and increase mistrust of paper
money. An inflationary monetary policy would therefore lead to a loss of gold from the central bank
because it would drive down the value of the domestic currency and force the central bank to
selldomestic assets to the public (=decrease the money supply). During the interwar years the link to
gold was finally abandoned and the problem that arose was about how the monetary authorities
should be constrained from embracing inflationary polices. Two major changes contributed to public
acceptance of fiat money: accountable government and an independent central bank.

Weak governement such as those in France and Germany immediately after the First World War were
forced to please the electorate by public spending, but were enable to raise sufficient revenues from
taxes. After the monetary reforms of the mid-1920s, nations with an inflationary history granted
national banks greater independence and/or restricted government involvment in central bank policy.

WHAT DO BANKS DO?
When banks started to practise fractional reserve banking, they clearly entered a new phase by
increasing the money supply in addition to facilitating trade by providing foreign exchange and
clearing services between accounts. In the nineteenth century banks expanded their role as
intermediaries between savers and borrowers by lowering transaction costs and risks for both the
parts.
Since problems of information asymmetries between savers and borrowers can occur, theres need for
an intermediary hence banks thrive by exploiting economies of scale and gains from specialization in
collecting and analyzing information about borrowers. Futhermore savers want their assets to be
liquid, that is they prefer to be able to convert their deposits to money at short notice. Borrowers, who
typically will be investors in fixed capital, need a long-term committment from their creditors because
of the illiquidity of their investments. Banks learn how to transform short-term liabilities (deposits)
into long-term assets (loans) by holding appropriate liquid reserves which can be used to service
depositors when they ocasionally and o short notice want to withdraw money.
Investors also have an information problem in finding willing long-term lenders outside the circle of
close associates, family and friends, who were a major source of lending in the early phase of economic
revival in Europe, and continued to be so well into the initial phase of industrialization.

39

In return for long-term credit (during the nineteenth century), banks needed to monitor the
performance of borrowers and they do that by a mix of supervision and penalities imposed on
borrowers who do not perform adequately. This system runs because banks accept deposits and
promise a positive return, and interest rate, and the right for depositors to reclaim the deposit at a
fixed nominal value. Banks also manage a portfolio of assets: they offer fixed nominal value loans to
borrowers, but the underlying asseta s an uncertain future value. Inevitably, banks occasionally
miscalculate bacause it is inherently difficult to assess the future value of an asset and this will trigger
off a chain of events: borrowers cannot pay back their loans, depositors fear for their deposits and run
to rescue them, banks have liquidity constraints and will fail in the absence of a lender of last resort, a
central bank.

THE IMPACT OF BANKS ON ECONOMIC GROWTH
The impact of banks on economic growth operates through three mechanisms:
1. The impact on the saving ratio (savings as a share of national income)

We dont have adequate data on savings in the preindustrial period, we suspect that the

savings ratio rarely rose above 5% of national income while in the second half of the

nineteenth century, savings increased considerably and varied between 10 to 20% of

national income.
2. The impact on the efficiency of the use to which savings are channeled
3. The effect of increased monetization of the economy.

P.Rousseau looked into the impact of the monetarization of the the Dutch economy on the activity of
the trading companies and found a strong link in th seventeenth and eighteenth centuries; cash
constraints were serious impediments to investment. Moreover, he found that monetization had a
strong impact on industrial production from 1730 to 1850 (good part of the inustrial revolution).

Citizens of small to moderate means were initially reclutant to trust banks due to frequent banks
failures. The savings banks that developed all over Europe in the early nineteenth century were meant
to provide ordinary citizens with safe deposits and, by implication make them familiar with bank
practices but due to the fragility of trust, savings banks initially had to pursue a very conservative
asset strategy.
Despite the care savings banks showed in evading risky investments, they played an important role in
providing finance for infrastructure investments, and over time they developed an asset strategy not
very different from other banks.
The other element in nineteenth-century banking development is the emergence of the joint-stock
bank, which relied less on depositors money and more on ivestors capital. These banks were not
constrained by depositors preferences for liquidity and were urged by heir owners to adopt a less
conserative loan strategy in order to increase returns to the owners. These banks were involved in the
financing of commerce and industry but through the twentieth century the differences between these
two types of banks diminished. Joint-stock banks built nationwide branch offices and attracted
deposits, often in competitions with the savings banks. However, some joint-stock banks developed in
another direction and became pure investments banks, servicing industrial firms and helping in
mergers and acquisitions.
Banks specialize in gathering information about borrowers solvency and the viability and profitability
of investment projects. In doing so, they typically set up stric criteria which must be fulfilled before a
loan is granted. There could be an assymmetry of information that could be the source of potential
cheating on the part of the borrower hence banks must also regularly monitor their borrowers and be
alble to penalize them if they dont live up to expectations on which they were granted loans.
Therere studies that confirmed that bank depth (the volume of financial intermediation in the
economy) is positively linked to investment and productivity growth when other relevant factors that
affect growth have been controlled for; bank managers aim to select the most promising technologies
and they monitor firms, but in the stock market a large number of unco-ordinated individual traders
and investment fund managers do the same job.
Even if both stock markets and banking systems were developed they had different importance. In the
early nineteenth century only Britain had a weel-developed banking system, consisting of a wide

40

network of country banks and a strong centre in London. It provided mostly short-term credit to
industry and commerce bill discounting and deposit banking. The rest of Europe had a financial
system which was nota t all adequate for the tasks ahead.
Alexander Gerschenkron argued that this backwardness in continental Europe prompted banks to play
a more active role in fostering industrial development by establishing close links between themselves
and industry.
William Kennedy, according to the fact that banks were unable or unwilling to provide industry with
the necessary finance (and hence they slowed down industrial progress), showed that british
merchant bankers were risk-averse, invested in lower-yielding assets and thereby made life hard for
evolving, but more risky technologies.
British banks excelled in commercial banking, which included the discounting of bills and the
provision of short-term credit and for this reason the British system is known as transaction banking.
The system developing in France and Germany had the commercial banking functions but then added
a number of other services, such as investment banking and mortgages for houses and since they
embraced a variety of activities they have been termed universal banks. Some of universal banks
preferred to take a long-term stake or provide varieties of corporate finance to particular firms; this
approach has earned the name of relationship banking. Relationship baniking is supposed to dimish
the problem of asymmetric information anf constrain cheating by borrowers by establishing a
relationship of trust between entrepreneurs and banks.

BANKS VERSUS STOCK MARKETS
Stock markets enable savers to diversify risk and provide equity (shares or stocks) which is liquid for
savers but a long-term committement for borrowers. Stock-market traders exert control by exit or
entry, whereas bank managers monitoring firms voice their concerns and penalize borrowers if
necessary.
Mutual funds, which invest in a portfolio of stocks, can thrive because they can exploit economies of
scale ingathering information which individual savers cannot.
Stock markets in europe developed as modern banking emerged in the second half of the nineteenth
century , which suggests that stock markets and banks are complementary rather than rivals.
And the reason why banking reach a sophisticated level of development before stock exchanges has to
be find in the fact that banks and stock markets deal with different assets. Stock market strade
marketable assets, that is stocks in firms large enough to bother issuing them, while banks deal with
non-marketed assets. Banks extend loans to firms against collateral in non-marketed assets such as
buildings, inventories and machinery and the value of these assets is difficult to asses.
The different development of the two entitities is explained by Gerschenkron through the theory of the
path dependece based on the argument that large banks in Germany were particulary well suited to
provide finance to industry at a crucial formative moment and that they subsequently stifled the
development of the stock market.

41

42

43

BOGART, DREICHMAN, GELDERBLOM AND ROSENTHAL, State and private institutions

Economic growth depends upon institutions. We focus on those institutions that are formal and
publicly enforced.
Economic historians have long ephasized the role of institutions in ensuring prosperity. Scholars have
particularly highlighted the benefits of secure property rights and in this light, Englands early
economic leadership sprang from the Glorious Revolutions institutional settlement. The great variety
of political and economic, public and private institutions that prevailed in Europe offers a tempting
ground for testing this largely inductive argument based on Britain. Although the variation in
institutions is extensive, it raises its own problems: institutions, archaic or modern, are chosen.
Furthermore, in the long-run all institutions are sub-optimal; only change can allow growth to go
foreward. Since Britain was the most successful economy in the period it seems natural to use ita s a
benchmark. Finally, economists have focused heavily on national output, neglecting regional variation.
The British institutions associated with the Industrial Revolution are equally connected to the Irish
economy and the potato famine.
Its also important to note that, if by 1870 the notions of state and antion had become interchangeable,
this was not so in 1700.
The recombination of territories in eastern and central Europe poses obvious problems for us since
while we try to consider the whole of Europe, this is not always possible. While economic historians
have often written the economic history of Europe as growth springing from the peoples liberation
from oppressive rulers, in many places growth arose from the elimination of gepgraphical
fragmentation and local privileges and practices.

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POLITICAL INSTITUTIONS
Between 1700 and 1870 European political units underwent complex, profound and often locally
specific transformations.
We focus on three broad trends:
1. Absolutisms continued rise from the sixteenth through the eighteenth century
2. Its complex replacement by constitutional regimes in the nineteenth century
3. The ascendance of the nationl state over both territorial empires and confederations of small
sovereign units.
For millennia empires were the dominant polities around the globe. Yet in Europe they succumbed to
a tide of national states, which one could see rising after the Peace of Westphalia in 1648. The Hasburg
and Holy Roman Empire survived but their control over territories other than their traditional bases
waned ans by the outbreak of the War of the Spanish Succession in 1702, national states were gaininig
the upper hand in Europe.
Charles Tilly traces the success of national states to their absorption of the fiscal extraction system and
military organizations into administrative units. Early modern European polities had largely relied on
indirect (decentralized) rule for their coercion and extraction needs. While centralization was known
to be more efficient, it was also much costlier. Gonzalez de Lara, Greif and Jah argued that medieval
potentates chose indirect rule because it was cheap and their ororganizational choice proved
persistent. Decentralized administration also contrained the capacity of european rulers to extract
resources from their subjects, wage war and control large territories. But by the turn of eighteenth
century the tide was turning; rulers increasingly brought fiscal and military strctures into their
administrative structures, thereby sedding the layers of intermediaries on which they had relied to
negotiate with the elites. Sitting representatives assemblies, became rare; fiscal operations were
wrestled from rpivate control and subjected to central oversight; state finance ministries increasingly
substituted for bankers and capitalists to whom kings had often outsourced their borrowing needs and
professional mercenaries were repleaced by standing armies, composed almost exclusively of
nationals of the states they belonged to. The fate of the countries that did not implement such reforms
reveals their importance (ex. Poland that finally was divided between Russia, Austria and Prussia,
Hungury was absorbed by the Ottoman Empire). As a rule, small states incapable of fielding standing
armies and dominated by traditional elites were absorbed by greater powers while slightly larger
states were enfolded in the fiscal-military machines of their more powerful neighbours.
Two polities stood at the vanguard of change. Britain distinguished itself from the European norm
wiht the construct of the Crown-in-Parliament and the other instituitonal innovations of the Glorious
Revolution. The great bargain of 1689 began a process whereby the kingdom acquired a
representative assembly, a strong executive, a professional bureaucracy, and financial institutions
designed to cater to the needs of the state. Many of these innovations were imported or adapted from
the Netherlands, the most successful of the handful of republics that survived in Europe.
While representative bodies with actual power survived, most polities shifted to direct absolute rule.
One of the main dimensions along which absolute monarchies can be classified is their elimination of
alternative political forces. The elimination of the intermediaries took root with the most vigor in
Prussia, Russia, and Austria (but also Spain, Portugal, Sweden have to be mentioned).
France made some strides under Louis XIV, who succeeded in co-opting the nobility and reducing the
power of the parlements to block royal edicts but the venal French system blocked deeper reforms.
They also constituted one of the main forms of government debt.
The Anciene Regime was the classical example of wht Ertman has called patrimonial absolutism
where the different bodies that constitute the state are the private property of individual elites. After
Louis XIVs death the elites used their control of state institutions (the parlements) to defend their
special interests against the several attempts at enlightened reform.
During the French Revolution there were few moments of creative destruction; the National Assembly
sought to eliminate the intermediary bodies of the Ancien Regime (parlements were dismissed, local
assemblies were abolished along with all feudal privilege, the Church was dispossessed of its wealth
and almost all guilds were dissolved). However the revolutionaries found themselves unable to give
France a stable political order, a task thaht fell Napoleon and that involved the reemergence of an
autocratic empire in Europe.

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Napoleons most lasting institutional innovation was the codification of civil law, which was carried by
French armies across Europe hence it has to be considered as the Revolutions most significant export.

The second and third quarters of the nineteenth century were characterized by what Finer has called
the constitutionalization of Europe. Constitutions that survived more than a few years were
overwhelmingly granted by sovereigns rather than proclaimed by revolutionary assemblies.
Finer characterizes three types of constitutions:
1. neo-absolutist charters left most of the power in the hands of the ruler, although some
maintained rump legislatures, often titled towards the nobility and the landed elites.
2. Constitutional monarchies in which power was delegated to ministers answerable to the king
3. Parliamentary monarchies where ministers responded to elected legislatures.
(examples of states that started with consitutional and switched to parliamentary:
Austria parliamentary system in 1867, France oscillated between the two systems but
finally became a parliamentary republic)
By 1870 only Russia and the Ottoman Empire maintained absolute governments without
constitutions.
European polities also provided a wide array of political and economic freedoms in fact by
1870 all areas of Europe (except for the Ottoman Empire) had abolished slavery and serfdom.

FISCAL INSTITUTIONS
In the eighteenth century European states raised revenues to fight wars and they decided to do so
through a combination of taxation, wartime borowing and ever growing public debt.
Rulers knew that international competition was expensive, and that in turn coloured all domestic
political processes.

This ranking reflects the reality the political reality of eighteenth-century Europe, with France and
England vying for leadership buti t aslo shows that size mattered (since we can notice that the tax
revenues per capita in Hamburg were as high as in England but its tiny population prevented it) hence
total revenue is what mattered for military and political leadership. Because of the differences in size,

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the revenues reported in 1765 cannote serve as a mesure of fiscal intensity in fact weve to take into
consideration the GDP.
During the eighteenth-century, states suffered from divergent fiscal success (and this is confimerd by
their respective per capita tax burden measured in daily wages of unskilled laborers).
The avaible data for the period 1740-1790 shows Holland as the fiscal champion, with England
catchinug up after 1780; however in both countries in the 1790s the average person paid up to the
equivalent of one months daily wages in taxes per year. Different was the situation for France where
the states performance improved between 1740 and 1770 even if it trailed far behind England and
Holland until the Revolution and the same was for the Habsburg lands.
A possible explaination for these differences is the substitution of indirect taxes on real estate,
revenues from royal domains, or the sale of monopoly rights as happened in England, Holland and
France while countries like Prussia and the Hasbourg monarchy relied even more heavily on domain
revenues, land taxes and the sales of monopolies (in fact in 1765 the rulers of the Hasburg lands as
weel as the ones of Spain still drew a considerable part of their income from their own possessions).

Even if indirect taxtation was so much better, it wasnt that easy to to emulate England and Holland
because of:
a lack in parliamentary control of taxation and expenditures;
the fact that the states that failed were also composite monarchies (=amalgamates of
numerous territories with their own traditional liberties, political structures and fiscal
systems);
local particularism: traditional liberties allowed towns and provinces to administer taxation
and keep much of the income;
Urban autonomy (ex. In Holland a major political crisis was required before towns would hand
over two thirds of local revenues to the central government);
Noblemen, clergy, and sometimes even larger sections of the population, benefited from tax
exemptions.
Fiscal centralization would have solved these problems but achieving it required a major
redistribution of political power in all European states except England. This is why the French
Revolution and the subsequent Napoleonic wars were so important; France had to raise taxes and
loans to finance its conquest of Europe. England, as the only remaining opposition, had to fund an
unprecedented military campaign hence rulers decide to levy additional taxes on wealth and income in
order to raise capitals.
Napoleons conquests also forced the governments of Prussia, Spain and the Dutch Republic to
centralize their fiscal systems and part of these changes were reflected by the political reconfiguration
brought about by the Congress of Vienna after Napoleons defeat in 1815.
Fiscal centralization failed in Netherlands before the liberal revolution of 1848 because the abolutist
constitution of William I sidestepped parliamentary control over public finance. In Spain, several
decades of internal strife between absolutists, reactionaries and liberals preceded the unification of
the fiscal system in 1845.
The problems with fiscal centralization in most countries are reflected in the share of indirect taxes in
total revenues; in 1870 central government typically raised only between 20 and 40% of their revenue
through taxes on wealth income. But in 1870, most central governments taxes still amounted to less
than 10% of GDP.
The moderation of the tax burden also reflected the reduction in European warfare. The colonial wars
of France, England and Spain were much less costly or were lost early (ex:Spain). At the same time,
governments were unable or unwilling to offer anything beyond armies in exchange for the taxes they
levied. Hence between 1700 and 1870 central governments were perfectly capable of designing fiscal
institutions to raise money but they used these revenues only to fight wars or service the resulting
debts in fact the real problem was that they didnt consider tax increases for a more generous
provision of public goods.

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BUSINESS LAW
The political and fiscal changes discussed until this moment coincided with legal reform. For economic
historians, the real driver of law was found in advanced economies technological. More recently
economists have argued that common law countries institutions are the most responsive to economic
forces while countries that derive their law from Roman and later from French codes have institutions
that are at least responsive.
In law, as elsewhere, the French Revolution was a watershed. Reforms were extensive and culminated
in a series of codes (most famously civil, penal and commercial) and french battlefield successes
ensured that laws enacted in paris were diffused widely across Europe.
Before 1789 many Frances provinces had charters recognizing their specific legal heritage and fiscal
autonomy but unifying codes were enacted under Napoleon and have often been portrayed as giving
too much power to the executive. The codes were short and perforce incomplete. The nineteenth
century saw a steady stream of legislative action and a torrent of appellate decisions, both of which
served to complete the French codes.
Trade and industry were seen as needing different rules than those of the solid civil code;
if the civil code was debtor-friendly and procedually slow, the commercial code was creditor-
friendly and emphasized speedy resolution;

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where the civil code limited side contracts, the commercial code left business people
considerable leeway to devise rules to govern their interactions;
the civil codes reliance on government officials (notaries and judges) gave way to special
courts staffed by commercial people who relied heavily on arbitration by experts.
The codes diffused swiftly because Napoleon ruled over much Europe; between 1815 and 1860
Belgium, Italy, Netherlands, parts of Germany, Spain and Switzerland adopted these codes but with
sometimes substantial alterations.

Scandinavian countries also carried out large-scale legislative reform but without codes while Russia
and the Ottoman Empire escaped the early-nineteenth-century spread of civil and commercial law
reforms associated with codes. However, the new central European countries all adopted some form of
code.

The corporation is the emblem of public-private institutional collaborations during early
industrialization and success or failure at deploying corporations has been a frequent explanatory
trope in economic history; before 1850, each corporation was created as a specific grant by the
sovereign or the legislature to a group of individuals. A corporations purpose could include local
administration or the provision of public services but it could also include collecting the crowns taxes
and can be considered as antecedents to business corporations.
Corporations have three important attributes:
1. legal personhood (they could sue and be sued in court)
2. a lifespan independent of that of its initial memership
3. delegated management.
From the Middle Ages corporations and material gain had often been linked but the great recent
discoveries showed that in many cases Europes pursuit of empire and treasure depended on
corporations and the material gain was not a reward for having provided some public service (as it
was thought at the beginning).
Two obstacles prevented the expansion of corporations after 1700:
most rulers could not afford to liberalize rules about the creation of corporations without a
serious drain on their treasury
the foul reputation of equity claims after the collapse of the financial bubbles of 1719-21 in
Amsterdam, London and Paris.
Between 1800 and 1850 the general rule was that some corporations were formed in every country
but not very many, except in Belgium even if in the 1840s and 1850s the rules for creating

49

corporations were liberalized even because silent partnerships (limited partnerships with share,
known as commandities par actions) were not allowed so the request for a new joint stock was high.

ROADS
In 1700, most European road networks were maintained by local authorities and some of them
conscripted labour (known as the corve in France and statue labor in England), while others collected
tolls.
Many European states took steps to improve their road network. Even in this case England has to be
considered the leader, in fact by 1840 there were over 30.000km of turnpike roads thanks to the fact
that a local group presented to the Parliament a petition to form a turnpike trust, levy tolls and
improve a strech of road (hence there was a combination of local initiative with oversight of the
government).
England was followed by the Southern Netherlands.
Spain and France had different approaches; in France the royal government funded its roads and
established an administration to build and maintain them, secondary roads were the responsibility of
municipalities, often through corve labor (by 1800 France had 43.000km of roads, over half of which
were royal roads but after 1814, the French government increased the primary network from
25.700km to 34000km in the 1840). Another important innovation in France was that a law of the
1836 expanded municipalities fiscal authority and allowed departmental councils to raise taxes for
regional roads.

If we want to know how policies affected road infrastructure, weve to take into consideration several
dimensions such as network size, quality and cost of travel.
Political fragmentation also stifled investments in road networks since there were multiple
jurisdictions and even if a large absolutist state (like France or Spain) could solve this problem but in
many cases the crown did not have the political will or the resources to control all of its sub-units.

Waterway improvements included widening or diverting the path of the rivers and the building of
canals and some areas were fortunate in having many navigable rivers before 1700.

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Even in this case, Holland was a leader and the network of navigable waterways was financed and
owned by municipalities which received rights from provincial estates which issued octrooi (which
soecified rights of way and what fees municipalities could charge). By 1700 the Dutch had the most
exstensive waterway network in Europe, including over 650km of canals.
Canals were built in France during the seventeenth and eighteenth centuries but the waterway
network was not as dense but in the 1820s, Becquay proposed a network of waterways to be built
through concession contracts. Public-private partnerships were made in order to implement
Becquays plan; the state borrowed from private investors and agreed to split the profits once the debt
was repaired but in the 1870s the state bought out the companies interests and began financing many
of its own canals. By 1880, the French waterway network was largely government-owned.

After having analyzed the table, it could be spontaneous try to find an answer to the following
question: would waterways have been more extensive if French, German and Russian authorities had
adopted the waterway policies of England, Dutch and Belgians? Geiger argues that profits on French
canals were too low, due to low levels of urbanization and commercialization, to attract private
investors. And, in addition to this, there was the states inability to protect the property rights of
companies. Another thing that doesnt have to be underrated is that political fragmentation also stifled
waterway development.

RAILROADS POLICES
Railroads were the most important infrastructure investment in many European countries since every
state quickly realized the importance of railroads for economic development, military security and
political unification.
Many states decided that subsidies or direct ownership was necessary for railroad development but
three types of policy patterns appear before 1870:
1) one group of countries opted for private ownership combined with state subsidies, planning or
construction (France, Spain, Austria-Hungury, Russia and Italy) they guaranteed interest or
dividends for private railroads companies
2) the second group started with private involvement but shifted to grater state involvement
(Netherlands, Denmark and Norway)
3) the third group had a mixture of state and private partecipation from the beginning (Germany,
Sweden and Belgium).

Up to 1870 the United Kingdom and France had the highest degree of private ownership and both
followed the waterwayss policy models. In the UK, Parliament passed acts giving companies rights of
way and the authority to levy fees and, for this reason, the companies made substantial investments
without any subsidies from the Parliament. In France, the Ponts-et-Chausses did the planning and
engineering and the state gave companies leases on their lines for ninety-nine years and guaranteed
dividends on securities issued for new construnction. Six large railroad companies that owned most of
the french railroad network emerged and paris was connected by rail with all the reagions of France.

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States decided to increase their ownership of railroads because they believed that this would increase
military effectiveness and solidify their political power (Millward).

The following table suggests that railroad miles per capita or railroad miles per square were similar in
countries wit more private ownership or and in countries with more state ownership.

The years after 1870 witnessed new directions in the ownership and regulation of railroads, they were
nationalized in many European countries because they were a key asset in military operations and
they offered new sources of government revenue.

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 LEESON, An-arrgh-chy: The Law and Economics of Pirate Organization

To effectly organize their banditry, pirates required mechanisms to prevent internal predation,
minimize crew conflicts, and maximize piratical profit. Pirates devised two institutions for this
purpose: 1)the system of piratical checks and balances crews used to constrain captain predation;
2)they used democratic constitutions to minimize conflict and create piratical law and order. Pirates
are considered one of the most sophisticated and successful criminal organizations in history.

INTRODUCTION
Pirates were highly organized criminals. They couldnt use government to enforce or otherwise
support cooperative arrangements between them but despite this, they successfully cooperated with
hundreds of other rogues.
There are different theories that explained the reasons of the cooperation and the harmony among
pirates, the first one was Beckers one and he applied the logic of rational-choice decision making in
the context of organized outlaws; Fiorentini and Peltzman have to be mentionated since they provided
the most comprehensive collection of esseays that consider the economics of criminal organization.
The goal of the article is to investigate the internal governance institutions of violent criminal
enterprise by examining the law, economics and organization of pirates.
Their governance institutions were self-enforcing by necessity; they were clearly organized criminals
and were not primarly in the business of providing services to anyone other than their memebers.

A NEST OF ROGUES
Seventeenth and eighteenth century pirates occupied the waterways that formed major trading
routes; these areas encompass major portions of the Atlantic and Indian Oceans, Caribbean Sea and
Gulf of Mexico. The trade routes connecting the Caribbean, north Americas Atlantic seacoast, and
Madagascar formed a loop called the pirate round that many pirates traveled in search of prey.
The golden age of pirates extended from 1690 to 1730. The pirates of this era included many well-
known sea robbers.
Pirates came from different places and the crews were also racially diverse.
Pirates crews were quite large, the average crew (between 1716-1726) had about 80 memebrs. But
crews of 150-200 members were not uncommon; some crews were too large to fit in one ship and, in
this case, they formed pirate squadrons. In addition to this, multiple ripate ships sometimes joined for
concerted plunderinf expeditions.

MERCHANT SHIP ORGANIZATION

a. EFFICIENT AUTOCRACY
Although some pirates came from the Royal Navy, most sailors who entered piracy came from the
merchant marine and merchant ships were organized hierarchically; the hierarchy empowered
captains with autocratic autority over their crews. The capitains authority gave him control over all
aspects of life aboard his ship, including provision of victuals, payment, labor assignment, and crew
member discipline.

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Merchant ship autocracy reflected an efficient institutional response to the specific economic situation
these ships confronted and, in particular, the ownership structure of merchant vessels. Merchant ship
owners were absentee owners and they confronted a principa-agent problem with respect to the
crews they hired; in fact once a ship left port it could be gone for months hence ship owners counldnt
directly monitor their sailors. This situation invited various kinds of sailor opportunism. To prevent
this, ship owners appointed capitains to their vessels to monitor crews in their stead; centralizing
power in a capitains hands to direct sailors tasks, control the distribution of victuals and payment,
and discipline and punish crew memebers allowed merchant ship owners to minimize opportunism.
Admiralty law facilitated capitains ability to do this by granting them authority to control their crews
behavior through corporal punishment.
To align owner-capitain interests, owners used two devices: 1)owners hired captains who held small
shares in the vessels they were commanding or gave small shares to the captains who did not
2)absentee owners appointed captains with familial connections to one of the members of their group
this ensured that capitans did not behave opportunistically at the absentee owners expense since
they were more likely to face punishment.
A capitain who did not have total authority over his crew could not successfully monitor and control
sailors behaviour. Reducing the capitains power over victuals, payment, labor assignment, or
discipline and vestingit in some other sailors behaviour.
Marchant ship autocracy was therefore essential to overcoming the owner-crew principal-agent
problem and thus to merchant ship profitability.

b. THE PROBLEM OF CAPITAN PREDATION
merchant ship autocracy created potential for a different kind of problem: capitain predation. The
trouble was that a captain endowed with the authority required to manage his crew on the ship
owners behalf could also easily turn his authority against his seamen for personal benefit.
Betagh argue that merchant captains were not necessarily bad men but they were rational economic
actors and thus responded to the incentives their institutional environment created in fact come
captains their power to prey on their sailors. They had he power to mae life tolerable or unbearable
as they wished and unfortunately many of them opted for the unbearable choice. To keep their hungy
and unconfortable men in check, abusive capitains could and did use all manner of objects abroad
their ships as weapons to punish insolent crew members, they hit sailors in the head with tackle or
other hard objects on board, crushing their faces, and used other barbaric tactics to discipline seamen.
Besides preventing dissension, captains also used their kingly power to settle personal scores with
crew memebers. Admiralty law considered interfering with captain punishment mutinous and thus
prhibited crew memebrs from doing so. Although merchant captains ha sample latitude to prey on
their crews, this was not without limit even if none was able to prevent it entirely.
Reputation could also be effective in constraining captain predation; the relatively small population of
captains facilitated information sharing about captain behaviour.
Another potential check on captain predation was the threat of mutinity even if it was a risky and
costly method of checking an authoritys abuse. And another thing that weve to underline for this
situation is that even if every crew member agreed that the captain should be removed, sailors
confronted the standard collective action problems of small-scale revolution hence in order to make a
revolution, it was necessary that all the sailors were willing to fight. However the number of
documented mutinities is quite little hence we can adfirm that maritime revolution was not a reliable
method of reining in predatory merchant ship captains.

PIRATE SHIP ORGANIZATION
Pirates did not confront the owner-crew principal-agent problem that merchant ships did because
they didnt acquire their ships but they stole them. On a pirate ship, the principals were the agents, in
fact it was defined a s a sea-going stock company. This situation doesnt mean that pirates did not
need captains since many important piratical decisions required snap decision making. There was no
time for disagreement or debate in such cases. In addition to this, pirate ships, like all ships, needed
some method of maintaining order, distributing victuals and payments and administering discipline to
unruly crew memebers. The need for captains posed a dilemma for pirates; a capitain who wielded
unquestioned authority in certain decisions was critical for success and another problem was what

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was to prevent a captain with this power from behaving toward hi spirate crew in the same manner
that predatory merchant ship captains behaved toward their crews?
Since pirates did not have absentee owners but jointly owned, they didnt require autocratic captains
hence they democratically elected their capitains. Pirate democracy ensured that pirates got precisely
the kind of captain they desire and because pirates could popularly depose any captain who did not
suit them and elect another in his place, pirate captains ability to prey on crew memebrs was greatly
constrained compared to that of merchant ship captains.

a.PIRATICAL CHECKS AND BALANCES
Pirate were adamant in wanting to limit the captains power to abuse and cheat them and to do so they
instituted a democratic system of divided power, known as piratical checks and balances system
abroad their ships.
They instituted offices to manage themselves and the primary was the quartermaster; here captains
retained absolute authority in times of battle, enabling pirates to realize the benefits of autocratic
control required for success in conflict. Pirates crew transferred power to allocate provisions, select
and distribute loot and adjudicate crew memeber conflicts/administer discipline to the quartermaster,
whom they democratically elected. Impotant was also the role of the captain who was choisen to fight
the Vessels and he had more power than the quarter-master who had the general inspection of all
affairs and controlled the captains order (as it was deeply underlined by William Snelgrave). The
separation of powers was adopted by seventeenth and eighteenth-century on board(almost a century
before nations experienced it).
In addition to to this separation of powers, pirates imposed another check on captains autorithy; in
fact captains (as well as the quartermasters) were democratically elected and they cold also be
democratically deposed. If a quartermaster performed well, there were high possibilities for him to
became a captain.
This situation, let captains unable to secure special privileges for themselves at their crews expense
(and this is an important difference with merchant vessels).
The captains lodging, provisions, and even pay were nearly the same as that of ordinary crew
memebers.

b.Pirate Constitutions
Quartemesters had ample latitude to prey on crews and they were democratically elected from the
crews as well as they could democratically be deposed. To manage the power of the quartermasters
and the captains one, the pirate crews forged written constitutions that specified their laws and
punishments for braking these laws and more specifically limited the actions that quartermasters
might take in carrying out their duties. These constitutions originated with articles of agreement
followed on buccaneer ships in the seventeenth century; all bandits followed the basic rule of no prey,
no pay hence unless a pirating expedition was successful, no man received any payment.
The crew members were charged with different roles and these roles were awarded in different ways
and the wages were relationated to the total amount of the attack. When a ship was robbed, nobody
must plunder and keep his loot to himself, everything taken was shared among all the crew members
by equal portions.
Over time the buccaners institutionalized their articles of agreement and social organization and the
result was a system of customary law and metarules called the Custom of the Coast or the Jamaica
Discipline.
Eighteenth-century pirates built on this institutional framework in developing their own constitutions
that were created for the better conservation of their society, and doing justice to one another. The
basic elemets of pirate constitutions displayed remarkable similarity across crews in fact frequent
intercrew interactions led to information sharing that facilitated constitutional commonality.
Articles of agreement required unanimous consent hence pirates democratically formed them in
advance of launching pirating expeditions. These kind of agreement were made also when multiple
pirate ships joined together for an expedition when they created similar articles to establish the terms
of their partnership.
With their constitutions, they created a democratic form of governance and explicitly laid out the
terms of pirate compensation in order to clarify the status of property rights aboard pirate ships and

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to prevent officers from preying on crew memebers. Other important things about the constitutions
are the following:
making the terms of compensation explicit helped to circumscribe the quartermasters
authority in dividing booty;
pirates articles prohibited activities that generated significant negative externalities and
threatened the success of criminal organization aboard their ships (in fact the pirates had to
keep their weapons in good working order, there were many activities forbitten on board such
as gambling);
these constitutions contained articles that provided incentives for crew memeber productivity
and prevented shirking (we can notice it from the creation of social insurance for pirates
injuried during battle)
a problem related to these constitutions was that this system can create incentives for free
riding and the laziness of one member reduces the the income of the others. To deal with this
problem, pirates created bonuses as well as punishments that varied in relation to the
infraction. Since the constitutions articles tended to be short and simple, they didnt cover all
possible contingencies that might affect a crew hence they were considered to be incomplete
but the crew memebers solved the situation by interpreting or applying the ships articles to
dituations not clearly stipulated in the article. This juridical review process let pirate crews
limit quartemasters discrtionary authority.

WAS PIRATE ORGANIZATION EFFICIENT?
A COMPARISON TO PRIVATEER ORGANIZATION
Pirates may have been quite successful despite their institutions rather than because of them. Ideally,
to make a real comparison with marine vessels we should judge the two organizations by how they
perform on the same economic activities; only in this situation we could more confidently conclude
that pirate organization reflected an efficient response to the economic activity pirates were engaged
in. Such vessels existed and were contemporary with pirate ships, they were known as privateers.
Privateers were private warships licensed by governments to harass the merchant ships of enemy
nations; they shared a predetermined portion of the proceeds from this activity with the
commissioning government. The licenses that established their legitimacy under the law were known
as letters of marque. The problem that occured was that privateers, like merchant ships, were owned
by absentee merchants hence they shared with merchant-ships the principal-agent problem. But
despite this important difference, privateers and pirate ships shared several significant economic
features, and this suggests us that the share systems efficiency was rooted in a specific economic
situation (large crews engaged in plunder).
Privateers also used constitutions similar to the ones used on pirate ships, the reasons for this
similarity are the following:
both pirates and privateers were in the business of sea banditry
because the goods they deal with and carried were always stolen, there were difficulties in
estabilishing property rights hence consitutions were used in both the situations to make
explicit crew member property rights to plunder. (this is an important difference with the
status of property rights on merchant vessels where these rights were totally clear since the
cargo carried belonged to the ships owner.)
both used a share system for payments hence the laziness of one crew member directly
affected the payment of the others hence in both the situations bonuses were codified (on
merchant ships there were fixed wages).
The similarities as well as the differences suggest two important items:
1) the institutional differences between pirates and merchants were driven by different economic
situations;
2) some major features of pirate organization were efficient independent of pirates inability to
rely on government in fact their efficiency derived from the particular economic situation
pirate ships faced.
One important difference of the economic situation of pirates and privateers was the ownership
structure of their ships while privateers and merchant ships were similar.

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A COMPARISON TO EXPLORER ORGANIZATION

A crucial feature of pirate organizations efficiency was its ability or inability to facilitate crew
cooperation that was a natural consequence of their way of life while the cooperation among the
memebers of a merchant ship was secured through the command of their autocratic captains.
The situations about which weve discussed until now are really different and its difficult to compare
the level and the sources of cooperation among crews members but theres another kind of ship that
weve to take into consideration and which will be useful to understand cooperations mechanisms in a
better way: explorer vessels.
Most explorer voyages did not seek profits; their purpose was to discover unknown parts of the world
and then to report their findings to curious landlubbers hence economic concerns did not play a
significant role in determining explorer organization. The party organizing an exploratory expedition
determined the ships institutional organization in fact the explorers institutions tended to reflect the
autocratic institutions of the governments navy, hence the resulting organization was similar to that
on merchant ships.
Examples of these organizations were: Magellans voyage (1519-1522), James Cooks voyage in search
of the discovery of the southern continent (1768-1771) and Scotts Antastic expedition (1901-1904).
Magellans voyage was hierarchically organized by the government and the government gave strict
instructions to the crew. During the voyage there wasnt division of power; the only moment of
democracy was afte the unexpected death of Magellan. Another important thing is that Magellan was
particularly violent with the crew memebers and not few were the sheeps that deserted. However
Magellan emerged victorious out of the violent mixup of the voyage. However the voyage did return to
Spain and it represented the first cirumnavigation of the globe, even if a lot of sailors died.
The same happened to Cook; Cooks captainship combined the powers of commander and ultimate
disciplinarian along the lines observed in the merchant and navy marine; there were five rules to be
observed by every persone in or belonging to the Cooks crew. Cook successfully accomplished his
voyage but his journal suggests that crew cooperation and harmony were strained.

However, what we can deduce from all these voyages is that democratic or self-governing vessel
organization facilitated crew cooperation at least as successfully as autocratic vessel organization.
Since pirates did not require autocratic organization to overcome the owner-crew principal-agent
problem that merchant ships confronted, this suggests that even if pirates had government
enforcement at their disposal, they would likely have opted for a democratic organization, such as the
one they used.
An important difference on the economic side is that none of the explorer captains considered above
stood to directly profit from cutting crew member rations, shorting crew memebers their pay, etc.
These ecplorer captains were not residual claimants of their voyages, as merchant ship captains were.
We can conclude that while autocratic organization opened the door for captain abuse on merchant
ships, it did not seem to do so significantly on explorer ships.

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TOPIC 4: THE INDUSTRIAL REVOLUTION

PERSSON, Knowledge, technology transfer and convergence, ch.6

INDUSTRIAL REVOLUTION, INDUSTRIOUS REVOLUTION AND INDUSTRIAL ENLIGHTENMENT
Its wrong to believe that the British Industrial Revolution (1770-1830) was based on a scientific
understanding of production processes; in fact revisionist scholarship initiated by Nicholas Crafts and
Knick Harley, during the closing decades of the twentieth century, argued that there was more of an
industrial transition than an industrial revolution.
Another thing that is necessary to rememeber is that Industrial Revolution was preceeded and
triggered off by what Berkeley and Jan de Vries called an Industrious Revolution: a fundamental
change in consumer behaviour. It was analyzed that increased income spilled over into an appetite for
new commodities.
Economic historians have become increasingly dissatisfied with the traditional view of the Idustrial
Revolution. Some suggest that the concept itself is a misnomer. Its true that new technologies were
introduced but the pace at which they were adopted was much slower than previously believed. Most
of these technologies were sector-specific rather than general-purpose hence they were not
applicable to a large number of different industrial activities. Steam engine was the main technological
innovation of the Industrial Revolution and also in this case it represents an exception because for
most of the eighteenth century it was used almost exclusively to pump water from coal mines. During
the initial phase of the Industrial Revolution, the major energy source for industry remained water
power, and thats why the factories were called mills.
What has recently been recognized is that the Industrial Revolution was limited to a revolutionary
change in certain sectors, specifically the textile industry.
The reinterpretation of the Industrial Revolution indicates that the technological changes that
occurred were the result of trial and error rather than scientific discovery.

Its not correct to talk about an industrial revolution if we mean a quick and sudden change to the
capita growth rate in fact modern economic growth prevailed in Britain from around the middle of the
nineteenth century and only by the end of the century in the rest of industrializing Europe. But this
slow acceleration of growth concealed fundamental changes in the intellectual climate, which
motivated his notion of and industrial enlightenment that flourished in that period.
The costs of accessing the new knowledge fell as scientific societies were formed both as a forum for
researchers to present new results and later to popularize and diffuse useful knowledge.
The industrial enlightnment was a uniquely European phenomenon; in fact the drift towards the use of
science in the control of nature for commercial purpose took place at time when technological
stagnation characterized the rest of the world. Europe was well prepared to be the unique location of
sustained economic growth fuelled by new knowledge-based technologies.

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The scientific societies formed before and during the Industrial Revolution were concerned with open
access to knowledge and therefore offered prizes and tried to discourage innovators from seeking
patents, however not few were the patents registered until the outbreak of the First World War.
The new era of sustained and higher economic growth has three characteristics:
1) From the middle of the nineeteenth century, science-based knowledge became a major factor
in economic growth;
2) The flow of inventions of new products and production processes stimulated investments;
3) Increasingly sophisticated technologies and production processes increased the demand for
education and human capital investment.

Its important to underline that science-based technology turned out to be much stronger in its effect
on growth.
The new technologies emerging in the late eighteenth and in the nineteenth centuries developed
production processes for known commodities; the single most important cluster of entirely new
technologies in the nineteenth century centred on electricity, which affected a large number of old
production processes and formed the basis for a large number of new products.
The general characteristics of the technological progress are the following:
Its resource saving,
Lessened the constraints of nature, in particular reliance on human and animal energy,
Improved the quality of commodities,
Developed new products and services,
Widened the resource base for industrial use.
The most surprising element of late nineteenth-century scientific discoveries was their lasting impact
on the tewntieth century; Fordism car manufacturing introduced standardized products suitable for
mass production. European industries did not have the same potential for economies of scale because
domestic markets were smaller and consumer preferences across Europe were less homogeneous.

The most important general-purpose technology of the twentieth century is electronic computing.

An important carachteristic of the knowledge is the fact that they are non.rival goods in fact they are
not exhausted when they are used.
A comparison across nations of income per head at a given point in time is a reasonably accurate
indicator of technological level, and technology transfer should therefore make it possible for less
sophisticated economies to grow faster because they can benefit from the application of superior
technologies invented in frontier technology economies. beta convergence: relatively poor
economies can expected to grow faster than the more adavanced economies once they get started.
There are three different reasons for this phenomenon:
1) Technology trasfer (that was a pan-European phenomenon and required a critical minimum
level of education, a banking system which supported innovative enterpreneurs and the
general institutional characteristics of a modern economy social capabilities by Moses
Abramovitz)
2) Aggregate level of an economy (the national product is the sum of the output of all sectors in
the economy but sectors tend to differ in terms of productivity)
3) Insights in growth theory (initially less developed economies have more scope for technology
catch-up, we should expect them to grow faster; furthermore, less developed economies have
less capital per labourer and there are therefore better prospects for profitable investments,
that is higher rates of return on capital.
We can notice that theres a negative relationship between initial income and subsequent
growth and this expectation became reality in the pre-First World War period and in the post-
Second World War period, when we had a linear regression.
While the situation is different if we take into consideration the interwars periods when the
regression suggest a positive relationship: the higher the initial GDP per head, the higher the
growth rate of GDP per capita in the subsequent period. This difference is explained by the fact
that the 1914-1950 period lacked the vital mechanisms for technology transfer-openness to
trade, capital and people.

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However small contries had a surprisingly active participation in the development of useful
knowledge, which revealed a high level of technical competence.).

Given that knowledge is transferable, its natural to look at institutional conditions when explaining
differences in performance; economies that under-performed initially tended to have a less developed
educational system and a less advanced banking system. Hence we need to focus in a more detailed
way on Germany and Britain in order to fully understand the differences in growth performance.

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