Indeed, in a sense we rely on governmental management and policing of our most-used system of resource management, namely, private property; we might think of the private property regime, taken as a whole, as a 'public property' owned and managed by governmental bodies.
Carol M. Rose (Property and Persuasion 1994, 109)
This paper will contrast the work of Douglass North and Karl Polanyi, both important institutionalists in the twentieth century, but with very different views regarding the essential characteristics of a market economy. For North, protection of individual private property is a necessary precondition, along with Constitutional commitment to an autonomous market and private rights. For Polanyi, there is an impossible separation between markets and politics. Further, North did not specify which type of property would be protected, while Polanyi enumerated land, labor, and capital, all "fictional" commodities, in his view.
To compare their views, I have chosen the context of financial institutions, a key aspect of market economies, with a long history of institutional development. While North pays less explicit attention to financial institutions, probably due to his more neoclassical orientation, he nonetheless makes trenchant observations that can be culled from his various historical works. Polanyi pays particular attention to the gold standard, but also observes the role of central banks in the management of flat currency.
Ostensibly, money is a clear example of the separation of public and private property. On the one hand, the miser's gold hoard is clearly his own private property. On the other hand, nonetheless, each gold coin is stamped with the insignia of the sovereign nation, an indication of its public nature. Based on a close reading of North and Polanyi, the position presented here is that money represents an inherently political collaboration between "private" wealth holders and the state, rendering such an unambiguous dividing line between public and private property untenable.
In particular, central banks form a core aspect of this examination, for several reasons. First, the organization of central banks in one country followed experiences and lessons learned in another. For example, Alexander Hamilton studied the Bank of England, in his role as the first Secretary of the Treasury in the United States, and the Bank of England in turn, was based on the example of the Bank of Amsterdam. Second, the role of the government and public finance is demonstrable in the operation of central banks and in the formation of public and private financial markets historically. Third, public debt, based on projected tax revenue, was an important private financial asset, with the government thereby playing a significant role in intertemporal exchange. Finally, this central role of the government as a financial intermediary places a public entity at the center of private financial markets, rendering the public/private divide less definitive than North would presume.
While private wealth holders would then be interested in monitoring the state budget, as North argues, this potential alliance of the state and wealth holders may place other parties in a position of reduced influence. That is, North's view of the self-enforcing nature of private property and the government finance may yield an alliance that would place Polanyi's "society" in a subordinate position. Society at large may not benefit as much by the process of monetization and the extension of markets, that is "growth," as much as wealth holders and the government. In fact, the historical record of financial institutions in the United States is replete with examples of such resistance.
North's evolving position regarding the role of wealth holders in representative government essentially concedes the importance of their political role. Ultimately, Polanyi's position regarding the impossible separation of markets and politics gains reinforcement from this unlikely quarter.
This paper will proceed by contrasting the positions of North and Polanyi on the market, the state, and the public/private divide. These comparisons will then be elaborated by an examination of the origin and role of western central banks, followed by a consideration of the development of U.S. financial institutions, where key concepts by both scholars can be illustrated. I conclude with a summary of their positions with respect to the case of finance, illustrating the essential connection between politics and markets.
Contrasting Approaches to the Market and the State
According to North, markets are based on self-interested voluntary exchange. If information and contract enforcement costs are too high, however, exchanges may not take place. The role of the state is to reduce such transaction costs by economies of scale and a monopoly on coercion. According to North, the state is also a self-interested agent; that is, the state must receive benefits in terms of revenues, which are greater than the costs of enforcement. The state is capable of opportunism, seeking its own gain at the traders' expense. So the efficiency and impartiality of the state as third-party enforcer of contracts must be enforced, in turn. Here, North develops the notion of "self-enforcing" contracts, by which all parties receive sufficient benefits to motivate compliance, even if all parties are self-interested (see also Greif 2006c). Certain "endogenous" political institutions, such as constitutions, separation of powers, due process, and universal suffrage, help provide information, support norms and beliefs, and develop public processes that motivate enforcement. Using this framework, North traces the development of a particular form of the state in England, with a central role in the protection of property rights, (1) with implications for economic growth.
Polanyi's approach to markets involves the notion of the "fictional" commodities of land, labor, and money. That is, these three factors of production are actually created for other purposes, rather than production for sale for profit. Land is part of nature, labor is human life, and money is a token of purchasing power, which "comes into being through the mechanism of banking or state finance" (Polanyi 1944, 72). In The Great Transformation, Polanyi traces the development of the market economy, building on previous works in history and anthropology, documenting the strain of the commodity form. For labor, human life is made subject to market discipline, the "prod of hunger," rather than be assured of the provision of basic needs. For land, ecology may be disrupted by the parcelization for the real estate market. And money, whether in the form of national flat or commodity currency, must be regulated or risk the destruction of business (Polanyi 1944, 131-132, 192). That is, the commodity that provides the basis for pricing and exchange of all other commodities, money, cannot be left purely to market forces. According to Polanyi, disruptions due to the form of fictional commodities, leads to a "double movement," by which society seeks to protect itself from the market. (2)
Examining North's historical texts in more detail, the protection of property rights emerged as a bargain between wealth holders and the monarch in seventeenth century England. The monarch, in need of secure financing for war, agreed to grant authority to Parliament to approve taxes. Parliament, representing merchants and landowners, sought protection for the conduct of trade and investment, and so was willing to share revenues for this purpose with the king. (3) By comparing the differential development histories of England and North America with Spain, Portugal, and Latin America, North suggests that the English/North American model is superior, because of successfully circumscribing the powers of the crown. North's hypothesis is that "the ability of a government to commit to private rights and exchange is thus an essential condition for growth" (North and Weingast 1989, 808). As part of this bargain, the state achieved a domestic monopoly over coercion, while the fiscal requirements of warfare were an important driver of the revenue system. The outcome of this bargain may have been different if England had had a standing army, like Spain or France.
In the detailed examination of the Glorious Revolution in England, it is clear that the property rights that North has in mind are those of wealth holders (North and Weingast 1989, 804, 817, 823; North 1990, 59).
What established the government's commitment to honoring its agreements--notably the promise not to appropriate wealth or repudiate debt--was that the wealth holders gained a say in each of these decisions through their representatives in Parliament. (North and Weingast 1989, 829) In this instance, North's principle is that the legislature represents wealth holders, giving them discretion over the use of their property, and the determination of the appropriate reward. Parliament succeeded in curtailing the absolute power of the monarch over the period of the 1640s to the 1690s, assuring wealth holders of security in their property holdings.
To. support his overall thesis that secure property rights are necessary for economic growth, North cites evidence which demonstrates the subsequent rapid expansion of financial markets in the eighteenth century. Yet he also recognizes that the private financial market came after, and depended on the extension of, the public financial markets. The expansion of the private market was exponential after the foundation of the market for public debt was established (North and Weingast 1989, 821-828).
The institutions leading to the growth of a stable market for public debt provided a large and positive externality for the parallel development of a market for private debt. (North and Weingast 1989, 825) Regarding the public/private divide, North has successfully demonstrated...