The Saving Lie: Truth and Method in the Social Sciences

Chapter 3. Gains from Trade

Chapter 3 Gains from Trade But the Chicago [S]chool just goes rolling along. Miraculously, all the evidence-! really mean, all the admissible evidence-strengthens their conviction, heldfor decades, that to err is human, and to live by rules is divine . ... [T]he Chicago School still adheres to the proposition that we should put our trust in stableformulas, not in unstable men and institutions. -Walter Heller, in Milton Friedman and Walter Heller, Monetary versus Fiscal Policy: A Dialogue The New Institutional Economics The model examined in this chapter, although still anchored in neoclassical economics, comes closer to reality than those so far discussed. It is designed to explain, among other matters, how economies that are inefficient nevertheless remain-miraculously, the ironic Heller might say-in existence. The question only arises if one first assumes that a market economy is a self-regulating system, evolving always in the direction of efficiency. If that is the case, natural selection should weed out units that are less able to produce wealth and allow more efficient units to survive. What is true of units should also be true ofeconomic systems, so that inefficient systems should be eliminated when they come into contact with efficient systems, and there should be a convergence of the world's economies towards whatever type best maximizes wealth. This has not happened, and, despite the claims for free-market capitalism, it still is not happening at the present day when techniques of managing and distributing information are more effective than ever before. One reason economic systems do not converge towards the optimum is that they are not self-regulating natural systems. To a degree, they are regulated by institutions, which belong to culture, not to na- Gains from Trade 47 ture. Institutions constrain the choices that entrepreneurs make and are themselves controlled by people more intent (in this conceptual framework) on their own advantage than on overall efficiency. For that reason inefficient economic practices survive. In short (and a paradox for the neoclassical paradigm) the old Adam, having a piece of the action, is to blame for the inefficiency. These ideas, which are more sophisticated than they appear in that brief sketch, are set out in a book by Douglass North, Institutions, Institutional Change and Economic Performance. He argues that institutions enhance trust, make trade possible, and thus, through specialization, increase productivity. But institutions, insofar as they are tools that the powerful can use for their own benefit, may also stand in the way of capturing the gains from trade. North retains the wealth-maximizing postulate (in most economic writing the default version of utility maximizing). His model also is "choice-theoretic." It is designed to show how different levels of productivity (the measure of efficiency) are functionally related to differences in institutions. Thus he stands away from Robbins and Knight and Milton Friedman and closer to Coase and the traditions of classical political economy. He does not assume that equilibrium (the point of maximum efficiency when markets are cleared) is automatically achieved. Instead, the process stops where someone stops it, and those who construct a particular "equilibrium" do so in their own interests. Institutions are defined as values and beliefs that are made operational in sets of rules, both formal (as in legal rules) and informal (as in customs). These rules specify goals, in pursuit of which people set up organizations, such as business firms, banks, insurance, the judiciary, the police, civil services, religious bodies, educational institutions, the military, and, of course, the state. Differences in economic efficiency (the ratio ofwealth produced to resources committed), whether across time or space (North makes frequent comparisons between Third World and developed industrial nations) are to be explained by showing how institutions enhance or inhibit the production of wealth. For example, the difference in overall economic performance between North American and Latin American countries, North argues, is in part a function of their different institutions; the highly personalized client-encouraging systems derived from Spain and Portugal make it more difficult to capture the gains from trade than does the relatively impersonal rule of law found in the English tradition. In this framework, the New Institutional Economics (NIE), there are some clear departures from an orthodox neoclassical economic 48 Expediency model.1 NIE is the domain of historians and is data-rich. It begins with data, for example, the amply documented mid-nineteenth-century antislavery campaign in the United States, which...