An evaluation of the role of the state and property rights in Douglass North's analysis.

Author:Fiani, Ronaldo

This paper intends to show that the role Douglass North has attributed in his latest works to the modern State in the working of economic system permits the development of a political economy theory which joins the political and economic dimensions with abstract generalizations quite different from and more interesting than the ahistorical and asocial neoclassical ones, at the same time avoiding a narrow descriptive character. Notwithstanding the fact that some of these ideas have been presented elsewhere, (1) more development is necessary, especially concerning the possibility of spontaneous cooperative behavior to dismiss the role of the State in property rights assignment and enforcement as a necessary condition for modern market functioning. Thus, the next section explores in North's analysis the links between transaction costs, multidimensional property rights, and third-party enforcement in modern societies, which demands the State's intervention not only in the enforcement but also in the definition of property rights, as a necessary condition for market operation.

The third section discusses the modern institutional analysis of spontaneous emergence of social cooperation essentially founded on Robert Axelrod's contribution, for its approach seems to contradict the role of the State as a third-party agent to define and enforce property rights. The fourth section discusses the determinants of the State's institutional action to define and enforce property rights according to North's analysis. Then, it will be demonstrated that North's analysis of these determinants is unsatisfactory but states a future research agenda for the study of the relationship between political and economic systems. The last section summarizes the most important questions for future research.

Development and Institutions in Douglass North's Analysis

The evolution of North's ideas is quite complex, and it is not our fundamental matter of concern here. We are interested in comparing North's approach in his latest work (during the 1990s) to the present trend of studying only the spontaneous emergence of norms through very abstract models in more orthodox approaches to institutions. However, some very brief remarks on the evolution of North's ideas are necessary, at least to let the unaware reader know about some quite dramatic changes in North's point of view in the course of his work.

North's first work (The Economic Growth of the United States from 1790 to 1860) was fundamentally concerned with an empirical analysis of the functioning of markets in a process of economic growth. This work would build the link between North and what have been called the "cliometric school" (also known as the "new economic history"), which was characterized by applying quantitative methods and (neoclassical) economic theory to historical analysis.

This initial link with neoclassical theory would prove very difficult to break in North's subsequent works. The most important difficulty with early North's neoclassical analysis would be to explain the permanence of inefficient institutions, that is, institutions that do not favor economic growth. (2) The problem of the definition of property rights, its assignments, and enforcement was directly related to the nature (efficient or inefficient) of institutions and has a central role in North's analysis.

The problem of the permanence of inefficient institutions would produce perhaps the most important changes in North's thought. In his early work on this issue (North and Thomas 1973), the definition, assignment, and enforcement of property rights always changed in an efficient way, in response to the variations in relative prices of land and labor. These variations were caused by the European demographic cycles during the Middle Ages, in a Malthusian-like cycle. Thus, a reduced population increased the relative price of labor in comparison to land and this, in turn, produced simultaneously a decrease in feudal obligations related to direct labor extraction and an increase in market-oriented usages of land, such as land tenancy. This movement produced population increase and the consequent expansion of agricultural frontier and the growth of commerce, which was caused by the diversity of agricultural products. However, as the stock of potential agricultural land was exhausted, diminishing returns started to operate producing inflation and increasing the price of land relative to labor: the whole cycle was reverted with landlords reducing the number of tenants on their lands and increasing the extraction of direct labor by the means of the imposition of feudal obligations.

In this early analysis of the process of economic growth and institutional change, the economic growth causes institutional change mechanically through individuals facing relative scarcity of labor and land. This is quite amazing when one considers that in the same book, North and Robert Thomas discussed the differences between the successful development in England and the Netherlands and the economic failure of Spain and France from the sixteenth to the seventeenth centuries (1973). While in the same period, first in the Netherlands and then in England, institutions were created to safeguard and enforce property rights, particularly in capital markets; in France and Spain, absolutist kingdoms made property rights insecure. The result was that while the Netherlands and England succeeded in overcoming the Malthusian check, France and Spain continued to be submitted to population growth cycles.

After reading the book, the inevitable conclusion is that it poses at least two problems:

  1. Why did France and Spain not imitate the pattern of property rights protection of the Netherlands and England?

  2. If the answer to problem 1 involves the State and its political structure, what were the differences?

    These two problems are quite difficult to handle without a theoretical model, and it is worse when the analytic frame preserves a clear neoclassical nature. The historical evidence points to the survival of property rights which do not favor economic growth for long periods. That could not be reconciled with the notion that property rights change spontaneously, in an efficient way, when factors' relative prices change. In his 1981 book, Structure and Change in Economic History, North tried to respond to both problems. North asserted then that "[t]he reason for the differential growth rates among the merging nation-states of Europe during the seventeenth century is to be found in the nature of property rights that had developed in each. The type of property rights established was the outgrowth of the particular way each nation-state developed" (148). The importance of North's change of approach must not be minimized here. He states that:

    (a) The concept of property rights is essential to understanding economic growth.

    (b) The development of property rights is specific to each nation, and it is not subject to a general, a historical law of change as it was before, when North considered development a spontaneous response to relative prices change.

    Before we develop the discussion of (a) and (b), it is important to properly understand the role of property rights in North's new approach. In effect, as we are going to realize, the concept of property rights is central to North's analysis of institutions through the impact of the costs of transacting in long-term growth. The first step is to carefully consider North's definition of transaction costs: "It is the cost of measuring the valuable attributes of the goods and services or the performance of agents in exchange that is the fundamental key to the cost of transacting" (1992, 7). This definition of transaction costs inherently relates these costs to the measurement and enforcement of property rights, (3) a kind of association not unanimously shared by authors of what became known as the new institutional economics. For example, Ronald H. Coase in his first article (1937), which coined the term "transaction costs," characterized transaction costs loosely as comprising all the costs incurred when a transaction is performed through the market, with no direct reference to what is really being transacted. More radically, Oliver E. Williamson (1990) explicitly denied any relevance to the concept of property rights in studying transaction costs: "Albeit illuminating, the property rights approach to economic organization pulls up short. Akin to the economic theory of socialism, which held that the central exercise was to 'get the prices right' ... the economics of property rights maintains that the basic need is to 'get the property rights straight'--after which markets will reliably assign resources to high valued uses. Arguments of both kinds truncate the study of economic organization unnecessarily" (109).

    Williamson's critique of the concept of property rights is unfair. While it is true that some authors have discussed property rights in a simplistic way, it is also true that others such as Armen Alchian, Yoram Barzel, and North himself have not. The latter understood that, as property rights always comprise multiple dimensions which are costly to measure, some of them remain unmeasured and so there is no such thing as perfectly assigned property rights. Property rights assignment and enforcement are and will always be problematic. For that reason institutions are so important: political and economic institutions assign and enforce property rights. This is the first analytical advantage of studying transaction costs by means of the concept of property rights.

    It must be clear that North acknowledges goods and services' multiple attributes, taking into account the difficulty of measuring them and the agents' performance as the source of transaction costs. Traditional economical analysis treats goods, services, and performances as essentially one-dimension objects--to be reduced to their...

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