[Paleopsych] CPE: Geoffrey M. Hodgson: The Evolution of Institutions: An Agenda for Future Theoretical Research
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Geoffrey M. Hodgson: The Evolution of Institutions: An Agenda for Future
Constitutional Political Economy, 13, 111-127, 2002.
The Business School, University of Hertfordshire, Mangrove Road, Hertford,
Hertfordshire SG13 8QF, UK g.m.hodgson at herts.ac.uk
[This is a frustrating article that addresses a big theme, namely that
there are institutional backdrops behind every institution that we observe
evolving. The article is as once too abstract and not abstract enough.
Just exactly what an institution is is never clearly specified. The
analysis could be so abstract as to include robots or just computer games,
and there would be no need to talk about people, as we know them, who
already have institutions, or rather social orderings, which we see this
in social mammals.
[Hodgson's prime example of a pre-existing institution is language, and he
is presumably speaking of human language and not just animal
communication. Those who use language already obey social norms: you do
have to shut up and listen and not bash someone who is trying to
communicate with you over the head and steal his property. Habermas
extended this simple idea to a complex notion of "communicative
rationality," and one that entails, so he claims, something not far from
the modern welfare state. Hodgson does not go to this length, but he does
not develop the idea that language usage would at least entail a certain
amount of peace (you do have to shut up).
[And his notion of preferences needs to be better specified. Economists
generally think of preferences as ordering bundles of economic goods, but
Hodgson seems to think preferences can also be for having and holding
habits of one sort or another. More still, habits, and preferences for
these habits (I guess that what's he struggling to get at) develop out of
[All this is very good, but the article needs a lot more concretes. Try to
supply them for your self as you sweat through the article, for the
general ideas of mutual co-evolution of individuals and institutions is
certainly among the most important issues there are. He makes only bare
reference to Boyd and Richerson's Culture and the Evolutionary Process, the
only iirc sociobiologically informed reference in the essay. And, as you
read articles that invoke supposedly purely rational calculator, look for
Unchecked anthropomorphic Premises. Too concrete a specification of a
calculating agents as being people as we now know them (think of Mr.
Mencken's depictions of man) will make difficult extensions to transhumans
This article reviews some theoretical questions concerning the processes
of institutional evolution. The necessity of assuming the prior existence
of some other institutions, such as language, is underlined. Arguably, the
emergence and stability of some institutions may be enhanced by processes
of 'downward causation' through which institutional constraints lead to
the formation of concordant habits of thought and behaviour. Having
pointed to the importance of pre-existing, as well as emerging,
institutions, this article reconsiders the possible role of the state in
the emergence and maintenance of some institutions, in particular money
and property. An agenda for future research is outlined.
JEL classification: B4, D0, K0.
Keywords: institutions, evolution, downward causation, habits,
constraints, the state.
In a book first published in German in 1871, Carl Menger (1981) pioneered
a basic analysis of how institutions evolve. His chosen example was the
institution of money. Menger saw money as emanating in an undesigned
manner from the communications and interactions of individual agents. He
started with a barter economy. As is well known, a problem with barter is
the lack of a general 'double coincidence of wants'. To deal with this
problem, traders look for a convenient and frequently exchanged commodity
to use in their exchanges with others. Once such usages become prominent,
a circular process of institutional self-reinforcement takes place.
Emerging to overcome the difficulties of barter, a prototype money is
chosen because it is a frequently used commodity, and its use becomes all
the more frequent because it is chosen. This circular positive feedback
leads to the emergence of the institution of money.
In this Mengerian approach, individual preference functions are taken as
given for the purpose of this analysis. The direction of analysis is from
the given individual to the emergent institution. Menger thus inspired a
central, unifying future project in both Austrian economics and the 'new
institutional economics': to explain the existence of political, legal, or
social, institutions by reference to a model of given, individual
behaviour, tracing out its consequences in terms of human interactions. 2
However, theoretical analyses or simulations of the evolution of money" or
other institutions" have proved to be remarkably problematic. For example,
in the work of Ramon Marimon et al. (1990) an attempt is made to model the
emergence of money with artificially intelligent agents. Their results are
highly qualified and partially inconclusive. A single monetary unit does
not always readily emerge. Menger's discursive analysis of an emergent
convention has proved to be remarkably difficult to replicate in a
computer simulation. 3
Attempts to simulate the emergence of other institutions or conventions
show similar difficulties. For example, in a simulation of the emergence
of a simple traffic convention Geoffrey Hodgson and Thorbjørn Knudsen
(2001) show that artificially intelligent 'drivers' negotiating in both
directions a two-lane circular track, do not always shift to the same side
of the road to avoid collision. Although this outcome sometimes appears in
this simulation, it is not guaranteed, even with foresighted and agile
It is also worth noting that, in the twenty years since the first mass
production of the cheap microcomputer, very few agent-based computer
simulations exhibiting the emergence of an institution along Mengerian
lines have been published. Computing power has become ubiquitous but
successful simulations along these lines have been rare. This is again a
ground for suspicion that the simulation of convergent outcomes may be
much more difficult than previously envisaged. Although convergence is
possible in many cases, many simulation runs lead to contrary outcomes,
depending on such factors as decision algorithms, parametric adjustments
and stochastic errors.
At the theoretical and methodological level, there is no clear consensus
among modern researchers as to what would constitute an adequate or
acceptable explanation of the process of emergence of an institution. This
question is at present under-researched. As a result, a contributor to the
'new' institutional economics found 'the "hard core" of this new research
program in disarray' (Sened 1997: 179-80). Oliver Williamson (2000: 595)
himself admits that 'we are still very ignorant about institutions.' These
assertions do not undermine the value or importance of the work of Menger
and others on the evolution of institutions. Instead they point to a
number of substantial research questions that remain to be answered. It is
the purpose of this essay to make some of these questions and issues
explicit, so that further research can address them.
Broadly, three types of question emerge concerning the Mengerian approach
to the analysis of the evolution of institutions. The first problem, which
will be briefly discussed here, concerns the theoretical impossibility of
starting from an institution-free 'state of nature' in the analysis of the
emergence of institutions. Several authors have already acknowledged this
problem, and a brief discussion is included for reasons of completeness.
It is the subject of section 2.
Section 3 considers the role of constraints in institutional evolution and
addresses the Mengerian 'bottom up' approach of starting from the given
individual. Given the lack of adequate support from formal analyses and
simulations, the Mengerian argument may not always be sufficient to
explain the evolution of institutions. On this tentative assumption, it is
suggested that real world institutional emergence may be aided by the
development of concordant habits, particularly as a result of emerging
channels and constraints. In some contexts, habit formation may greatly
enhance the formation and stability of institutions. It is argued here
that this is tantamount to the assumption of malleable preferences, along
the lines of authors in the 'old' institutionalist tradition. If such
mechanisms exist, then they are cases of 'reconstitutive downward
causation' in which institutions and constraints have a capacity to mould
individual preferences. 4 This argument is discussed alongside some former
claims from the literature in economics that suggest that institutional
constraints have more importance than formerly acknowledged.
Section 4 raises again the role of statutory and other forms of
intervention in the evolution and sustenance of institutions. One of
Menger's aims was to show that institutions could emerge spontaneously
from the interaction of individuals alone. He has thus been interpreted as
an opponent of the 'state theory of money', as found in works from
Aristotle through Georg Knapp (1924) to John Maynard Keynes (1930) and
others. However, Menger (1936  ) himself accepted that the
intervention of the state may be necessary to maintain the integrity of
the monetary unit in some circumstances. Accordingly, and more generally,
it remains a question of research and debate as to whether, and if so in
what circumstances, the state or other powerful organisations can
facilitate the emergence and stability of other institutions. Some
preliminary suggestions are developed here. Section 5 concludes the essay.
It must be emphasised that the aim of the article is to review the issues
at the current cutting edge of research in institutional economics. The
aim is not to provide final or definitive answers. To do so at the current
stage of research in this area would be dogmatic and unwarranted.
2. The Problem of Infinite Institutional Regress
We follow widespread practice and define institutions as durable systems
of established and embedded social rules that structure social
interactions. Language, money, law, systems of weights and measures,
traffic conventions, table manners, firms (and other organisations) are
all institutions. Such a broad definition of institutions has now become
widely accepted. As Menger and others recognise, this broad set of
institutions falls into a number of subcategories, including the division
between those that emerge spontaneously and those that result from a
process involving conscious design.
The work of Menger and many 'new' institutional economists is concerned to
show how spontaneous institutions can emerge, simply out of the
interactions of individuals, each pursuing their given purposes and
preferences. Andrew Schotter (1981: 5, emphasis removed) goes so far as to
define 'economics as the study of how individual economic agents pursuing
their own selfish ends evolve institutions as a means to satisfy them'.
Their emphasis is on a 'bottom up' approach: given a set of interacting
individuals, how do institutions then emerge?
The value of this work should not be denied. Substantial heuristic
insights about the development of institutions and conventions have been
gained on the basis of the assumption of given, rational individuals. The
main problem addressed here is the incompleteness of this research program
in its attempt to provide a general theory of the emergence and evolution
Alexander Field (1979, 1981, 1984) advances a fundamental criticism. In
attempting to explain the origin of social institutions, the new
institutional economics has to presume given individuals acting in a
certain institutional context. Along with the assumption of given
individuals, there is always a supposition of some rules of behaviour
governing their interaction. What is sometimes forgotten is that in the
original, hypothetical, 'state of nature' from which institutions are seen
to have emerged, a number of weighty rules, institutions and cultural and
social norms have already been presumed. Arguably, these original
institutions, roles and norms are unavoidable; even in an unreal 'thought
experiment' we can never properly envisage an original 'state of nature'
For example, in attempting to explain the origin of institutions through
game theory, Field points out that certain norms and rules must inevitably
be presumed at the start. There can be no games without rules, and thus
game theory can never explain the elemental rules themselves. As Field
(1984) argues, game theory may be used to explain the emergence of some
institutions, but to do so it has to assume a significant number of rules
and constraints at the outset. Even in a sequence of repeated games, or of
games about other (nested) games, at least one game or meta-game, with a
structure and payoffs, must be assumed at the outset. Any such attempt to
deal with history in terms of sequential or nested games is thus involved
in a problem of infinite regress: even with games about games about games
to the nth degree there is still one preceding game left to be explained.
As another illustrative example, Williamson (1975: 20; 1985: 143) writes
that 'in the beginning there were markets' . However, the market itself is
an institution (Hodgson 1988; Loasby 2000). The market involves social
norms and customs, instituted exchange relations, and" sometimes
consciously organized" information networks that themselves have to be
explained. All market and exchange relations themselves involve complex
rules and cannot be an institution-free or any other 'beginning'. As
Viktor Vanberg (1986: 75) puts it: 'What we call a market is always a
system of social interaction characterized by a specific institutional
framework, that is, by a set of rules defining certain restrictions on the
behavior of market participants'. Hence Williamson fails to explain the
evolution of the firm from an institution-free 'state of nature'. In a
type of comparative static approach, he implicitly assumes one
institutional framework and explicitly attempts to derive another.
Accordingly, the project of starting simply from given individuals is
These examples disclose a problem of potentially infinite regress.
Attempts to explain each emergent layer of institutions always rely on
previous institutions and rules. According to the Mengerian research
programme, these in turn have to be explained. Unless an institution-free
state of nature can be formulated or discovered, then the idea of
explaining all institutions in terms of individual interactions alone
faces an infinite chain of links to be revealed.
There is a fundamental reason why the idea of explaining all institutions
in terms of the interactions of individuals, starting from an
institution-free state of nature, must be abandoned. This is because all
individual interaction depends unavoidably on some" at least rudimentary"
form of language. Language itself is an institution. Individuals rely on
customs, norms and language in order to interact. Interpersonal
communication, which is essential to all stories of institutional
emergence, itself depends on linguistic and other rules and norms. The
institution-free state of nature is unattainable, in theory as well as
Individual choice requires a conceptual framework to make sense of the
world. The reception of information by an individual requires a paradigm
or cognitive frame to process and make sense of that information. The
acquisition of this cognitive apparatus involves processes of
socialisation and education, involving extensive interaction with others
(Mead 1934; Hodgson 1988). As well as language, these interactions require
other, pre-existing institutions. Individual choice is impossible without
them. We cannot understand the world without concepts and we cannot
communicate without some form of language.
What is being contested here is the possibility of using given individuals
as the institution-free starting point in the explanation. Institutions
are structures that can constrain and influence individuals. Accordingly,
if there are institutional influences on individuals, then these are
worthy of explanation. In turn, the explanation of those may be in terms
of other purposeful individuals. But where should the analysis stop? The
purposes of an individual could be partly explained by relevant
institutions, culture and so on. These, in their turn, would be partly
explained in terms of other individuals. But these individual purposes and
actions could then be partly explained by cultural and institutional
factors, and so on, indefinitely. We are involved in an apparently
infinite regress, similar to the puzzle 'which came first, the chicken or
the egg?' Such an analysis never reaches an end point. It is simply
arbitrary to stop at one particular stage in the explanation and say 'it
is all reducible to individuals' just as much as to say it is 'all social
and institutional.' The key point is that in this infinite regress,
neither individual nor institutional factors have legitimate explanatory
primacy. The idea that all explanations have ultimately to be in terms of
individuals (or institutions) is thus unfounded.
There is thus an unbreakable circle of determination. This does not mean,
however, that institutions and individuals have equivalent ontological and
explanatory status. Clearly, they have different characteristics.
Individuals are purposeful, whereas institutions are not, at least in the
same sense. Institutions have different lifespans from individuals,
sometimes enduring the passing of the individuals they contain. Their
mechanisms of reproduction and procreation are very different.
All theories must first build from elements which are taken as given.
However, the particular problem of infinite regress identified here
undermines any claim that the explanation of the emergence of institutions
can start from some kind of institution-free ensemble of (rational)
individuals in which there is supposedly no rule or institution to be
explained. Consequently, the project to explain the emergence of
institutions on the basis of given individuals runs into difficulties,
particularly with regard to the conceptualization of the initial
circumstances from which institutions are supposed to emerge (Hodgson
A reformulated project would stress the evolution of institutions, in part
from other institutions, rather than from a hypothetical, institution-free
'state of nature' . Notably, in recent years, a number of significant
studies have developed in this direction. Accordingly, Jack Knight (1992)
criticizes much of the new institutionalist literature for neglecting the
importance of distributional and power considerations in the emergence and
development of institutions. Even more clearly, Masahiko Aoki (2001)
identifies the problem of infinite regress in much of the former
literature and develops a novel approach. He not only takes individuals as
given, but also a historically bestowed set of institutions. With these
materials, he explores the evolution of further institutions, using game
theory. Other recent and significant studies of the evolution of
institutions also explicitly take other institutions as given (Howitt and
The next step, which Aoki recognises but does not fully complete, is to
develop a more evolutionary and open-ended framework of analysis. Instead
of focusing on just two points in time" the given starting point and the
evolved outcome" the next step is to develop an evolutionary approach, in
which the emphasis is on the ongoing process of change. We are reminded of
Veblen's (1919: 37) search for 'a theory of the process of consecutive
change, realized to be self-continuing or self-propagating and to have no
3. The Role of Constraints
The previous section pointed to a more open-ended evolutionary approach.
Once we take a step in this direction, another question is raised. If in
principle every component in the system can evolve, then so too can
individual preferences. Of course, most economists recognise that
preferences are malleable in the real world. But they have often taken the
assumption of fixed preferences as a reasonable, simplifying assumption.
In contrast, the possibility is raised here that some malleability of
preferences may be necessary to explain fully the evolution and stability
What is proposed here is a contingent and tentative hypothesis. We may
briefly sketch out a possible argument along the following lines. The
institutionalizing function of institutions means that a degree of order
and relative stability can be reinforced despite variety and diversity at
the microeconomic level. Institutions involve rules, constraints,
practices and ideas that can" through psychological and social mechanisms
that have to be specified" sometimes mould individual purposes and
preferences in some way. This preference malleability could improve the
possibility and stability of an emergent institution and overcome
difficulties in some cases where institutions fail to emerge.
Such intuitions can be found in the writings of the neglected tradition of
'old' institutionalism. For instance, Wesley Mitchell argues that the
evolution of money cannot be understood simply in terms of cost reduction
and individual convenience. He maintained that money 'stamps its pattern
upon wayward human nature, makes us all react in standard ways to the
standard stimuli it offers, and affects our very ideals of what is good,
beautiful and true' (Mitchell 1937: 371). Accordingly, the evolution of
money changes the mentality, preferences and way of thinking of
individuals themselves. This does not mean that Menger's insights
concerning the evolution of money are without value, but that they are
inadequate. Arguably, they have to be supplemented by an analysis of how
market institutions can change individual perceptions and preferences
(Bowles 1998). The idea of the malleability of individual preferences
pervades the 'old' institutional economics, from Thorstein Veblen to John
However, what is lacking in much of this literature is a clear exposition
of the causal processes involved. It is one thing to claim that
institutions affect individuals in a process of downward causation. It is
another to explain in detail the causes and effects. The most satisfactory
explanation of the relevant processes in the writings of the 'old'
institutionalists was in the writings of Veblen (1899: 190), who wrote:
'The situation of today shapes the institutions of tomorrow through a
selective, coercive process, by acting upon men's habitual view of
From this viewpoint, inspired by pragmatist philosophy and habit-instinct
psychology, the key element in this process is habit. Habits themselves
are formed through repetition of action or thought. They are influenced by
prior activity and have durable, self-sustaining qualities. However, habit
does not mean behaviour. It is a propensity to behave in particular ways
in a particular class of situations. Crucially, we may have habits that
lie unused for a long time. A habit may exist even if it is not manifest
in behaviour. Habits are submerged repertoires of potential behaviour;
they can be triggered by an appropriate stimulus or context. 6
Our habits help to make up our preferences and dispositions. When new
habits are acquired or existing habits change, then our preferences alter.
John Dewey (1922: 40) thus wrote of 'the cumulative effect of insensible
modifications worked by a particular habit in the body of preferences'.
Crucially, institutional changes and constraints can cause changes in
habits of thought and behaviour. Institutions constrain our behaviour and
develop our habits in specific ways. What does happen is that the framing,
shifting and constraining capacities of social institutions give rise to
new perceptions and dispositions within individuals.
Institutions channel and constrain behaviour so that individuals form new
habits as a result. At the level of the human agent, there are no
mysterious 'social forces' controlling individuals, other than those
affecting the actions and communications of human actors. People do not
develop new preferences, wants or purposes simply because 'values' or
'social forces' control them. What does happen is that the framing,
shifting and constraining capacities of social institutions give rise to
new perceptions and dispositions within individuals. Upon new habits of
thought and behaviour, new preferences and intentions emerge.
Elsewhere, this process of habit formation, resulting from institutional
channels and constraints, is described elsewhere as 'reconstitutive
downward causation' (Hodgson, forthcoming; Hodgson and Knudsen 2001). The
crucial point in the argument here is to recognise the significance of
reconstitutive downward causation on habits, rather than merely on
behaviour, intentions or beliefs. Clearly, the definitional distinction
between habit (as a propensity or disposition) and behaviour (or action)
is essential to make sense of this statement. Once habits become
established they become a potential basis for new intentions or beliefs.
As a result, shared habits are the constitutive material of institutions,
providing them with enhanced durability, power and normative authority.
A pressing issue for future research is the extent to which these
mechanisms of habituation play a role in different cases of institutional
evolution. What is being proposed here is; first, the possibility of a
viable causal mechanism by which institutions can lead to changes in
individual purposes and preferences; second, the possibility that such
mechanisms may lead to some degree of conformity; and third, the
possibility that such conformism may help to strengthen and sustain the
institution in question.
Note, however, that the process of conformism involving habituation is
quite different from the previous models of Stephen Jones (1984) and
Ekkehart Schlicht (1998) in which agents exhibit 'rule preference' or a
'preference for conformism'. In these models the problem of institutional
emergence is 'solved' by making some key properties of institutions also
the properties of individual preferences. In these analyses the preference
for conformism or rules is assumed as given at the outset. In contrast,
the mechanism of habituation points to the possibility of such preferences
being formed as a result of institutional channelling and constraint.
Preferences for rules and conformism are not assumed: their evolution is
To recapitulate, two important and connected issues have been raised here
as part of a future research agenda. The first is the possibility of
institutions having a reconstitutive effect on the preferences of
individual actors. The second is the key element in the mechanism of
reconstitution: the formation of habits through the operation of
institutional channels and constraints.
These issues relate to some former pieces of relevant research. In one of
his earliest papers, Becker (1962) demonstrates that behaviour ruled by
habit and inertia is just as capable as rational optimisation of
predicting the standard downward-sloping demand curve and the
profit-seeking activity of firms. Becker shows how the negatively inclined
market demand curve could result from habitual behaviour. Actors 'can be
said to behave not only "as if" they were rational but also "as if" they
were irrational: the major piece of empirical evidence justifying the
first statement can equally well justify the second' (Becker 1962: 4).
Kenneth Arrow (1986) has also accepted the possibility of an alternative
approach based on habit. Dhananjay Gode and Shyam Sunder (1993) went on to
show that experiments with agents of 'zero intelligence' produce
predictions that differ little from those with human traders. As in
Becker's (1962) model, systemic constraints prevail over micro-variations.
From these previous studies, two conclusions follow. First, the 'accuracy
of the predictions' or other familiar criteria for theory selection do not
give outright victory to rational choice models. Second, these models
suggest that ordered and sometimes predictable behaviour can result
largely from institutional constraints. As Andy Clark (1997: 276) puts it:
'The clear indicator of this is once again the fact that the explanatory
burden is borne by overall systems dynamics in which the microdynamics of
individual psychology is relatively unimportant.' The emergence of settled
patterns of behaviour may be either largely independent of the
deliberation of the agents, or even dependent on the existence of
behaviour dominated by habit or inertia. 8
The rediscovery of the role of habit in human behaviour and the
realisation of the powerful role of institutional constraints, together
point to the development of a research agenda focused on the
reconstitutive effects of institutions on individuals, and on the degree
to which institutional evolution may depend on the formation of concordant
4. A Possible Role for the State
Clearly, there are many different types of institution and they can emerge
and evolve in different ways. Some institutions" such as language" appear
and develop with little planning or state interference. A question of
importance is: what other institutions can emerge in a similarly
spontaneous manner? Alternatively, is the assistance of a powerful,
pre-existing institution required to create or sustain some other
institutions? As well as language, we here consider two more examples: the
institutions of money and of contract. In the earlier versions of his
theory, Menger saw the emerging monetary unit as homogeneous and
invariant. In this case there is no possibility of quality variation,
debasement or forgery. It is as if everyone is assumed to know 24-carat
gold when they see it. In reality, however, the emerging monetary unit can
be debased or forged. This would affect the process of monetary evolution,
as described by Menger. With potential quality variation, the purity and
value of the emerging monetary unit may be in doubt. Some actors may
notice the high frequency of the trade in a particular commodity, but
regard the commodity in question as unreliable and thereby avoid it as a
medium of exchange. Such problems, arising from potential quality
variation, could subvert the evolution of the monetary unit.
In later discussions of the evolution of money, Menger did raise the
question of potential and covert quality variation. But at first he
dismissed the problem, saying that money is likely to take the form of
precious metals, and these are 'easily controlled as to their quality and
weight' (Menger 1892: 255). Later, however, in his article on 'Geld',
Menger recognised that the problem of potential quality variation could be
so serious that the state had to play a role. Menger (1936 : 42)
thus wrote: 'Only the state has the power to protect effectively the coins
and other means of exchange which are circulated, against the issue of
false coins, illegal reductions of weight and other violations that impede
trade.' Nevertheless, Menger applied this argument to a 'developed
economy' only. He was reluctant to admit that the state was necessary to
protect the integrity of the monetary unit at earlier stages of economic
development, and he still clung to his view that, in essence, money was a
phenomenon independent of the state. Arguably, however, debasement is a
potential problem at the inception of money, not merely at its developed
Of course, another strong institution, or coalition of traders, may be
able to overcome some of these problems, as an alternative to the state.
However, there is a particular reason why the state is more likely to take
this role. While Menger was right to emphasise that many social
institutions emerge and develop without a conscious plan, it is often the
case that an institution reaches an important stage of development when it
becomes consciously recognised and legitimated by other institutions. It
is possible that the formation of habits of thought and action that are
concordant with the emergent monetary unit are reinforced by other
already-formed habits of obedience and deference to the state. Symbol and
ceremony have an important part here. Money has self-regulating and
spontaneous properties, but typically it is also endorsed by another
powerful socio-economic institution. Although state decree alone is far
from sufficient to create money, as a commanding social institution at the
apex of the legal system, the state is well positioned to take on this
declaratory and legitimising role. In legitimating a monetary unit and
helping to engender trust in it, the state relies on its crucial symbolic
as well as its legislative powers. It is not accidental that the images of
monarchs and presidents adorn many notes and coins. Menger's original
account of the origin of money as a purely spontaneous process downplays
these declaratory aspects and their symbolic representations. This
argument does not imply that the state is necessarily the best or more
efficient solution. It suggests that the state is well-positioned to take
a regulatory role, and if this develops then the state can make use of its
substantial symbolic, ceremonial and legitimatory powers.
If legal or state instruments are necessary to some degree for the full
development of money, then these elements could reasonably account for
part of the essence of money itself: they are more than mere accidental,
historical appearances. As a result, Menger's argument against the 'state
theory of money'--as promoted by the German historical school and others--
would lose some of its impact. Furthermore, if the state and other
institutions are necessary at the very point of conception of money, then
they, along with individuals, have to enter as elements in the explanation
of its emergence and development. 9
It is reasonable to ask the question why the evolution of the institution
of money may require some state involvement but, in contrast, institutions
such as language may emerge spontaneously. It has been argued elsewhere
(Hodgson 1993) that a crucial difference is whether or not an institution
has intrinsic error-correcting or self-policing mechanisms. The
philosopher Willard van Orman Quine (1960) makes the point that language
has an error-correcting regime. Individuals have an incentive to make
their words clear. As an essential condition of communication, the coding
itself (the signifier) must be unmistakable, even if the meaning (the
signified) remains partly ambiguous. In communication we have strong
incentives and inclinations to use words and sounds in a way that conforms
as closely as possible to the perceived norm. Although languages do change
through time, there are incentives to conform to, and thus reinforce, the
linguistic norms in the given region or context. Norms of language and
pronunciation are thus largely self-policing.10
Similarly, some legal rules have a strong self-policing element. For
example, there are obvious incentives to stop at red traffic lights and to
drive on the same side of the road as others. Although infringements will
occur, these particular laws can be partly enforced by motorists
themselves. However, things are very different with many other laws and
institutions. Laws that restrict behaviour, where there are substantial,
perceived net advantages to transgression, are the ones that require the
most policing. Hence people frequently evade tax payments or break speed
limits. Without some policing activity the law itself is likely to be
infringed, debased and 'brought into disrepute.'
Likewise, there are incentives to debase money. With potential quality
variation, individual agents have an obvious incentive to use a less
costly or poor quality version of the medium of exchange in preferment to
the good. Given that traders cannot readily detect all variations, then
forgeries and debasements are possible. If they are allowed to endure,
then bad money will drive out the good. Money is not self-policing in the
same way as language.
Accordingly, any self-policing mechanisms can be undermined if there is
the possibility of undetected variation from the norm and there is
sufficient incentive to exert such variations. Language and money differ
in this respect. The argument for the intervention and policing of the
state is thus much stronger in the case of money and some laws, than in
the case of language.11
We turn now to the institutions of contract and private property. In this
case it would seem that without the threat of the legal system and the
courts, people might often default on contracts and take what is not
theirs. Despite this, there have been several attempts to explain the
evolution of property without the involvement of the state or a developed
legal system. For example, Williamson (1983, 1985) addresses the latter
problem in one of his excursions into legal theory, arguing that property
can emerge through 'private ordering', that is, individual-to-individual
transactions, without state legislation or interference. In particular,
Williamson discusses the part that 'hostages' may play in enforcing
transactions. A 'hostage' refers to such arrangements as where both
parties to an agreement are committed to non-salvageable costs. The effect
is to tighten the bond between the parties and reduce the risk of
contractual default. Thus, in the view of Williamson and others, a
workable system of property and contract is possible without the state.
Some recent work in economic history has been interpreted as support for a
similar view. There are historical cases, in the absence of an
over-arching authority, where there has been a problem of contract
enforcement in trade between one community and another. There was often no
dominant political power or supra-national authority to resolve disputes.
For instance, early medieval international trade depended on reputation
and sometimes relied on coalitions, guilds, kinship links or religious
ties to sustain enforceability (Greif 1989, 1993, 1994; Greif et al. 1994;
Landa 1994; North 1991). Even in more recent times, in the absence of an
adequate international political or legal authority, such institutional
structures have assumed quasi-legal powers (Clay 1997). Several of these
cited articles show, using game theoretic models with a few players, how
trading coalitions can evolve. These historical studies show that in the
absence of a strong (international) legal authority, quasi-legal
institutions emerged to help regulate and enforce contracts. The
historical evidence suggests that quasi-legal institutions such as trading
coalitions are likely to develop in the absence of legal and statutory
ones. We can conclude that trade generally may rely on extra-legal as well
as legal powers of contract enforcement. However, it would be wrong to
presume that extra-legal institutions are always adequate or efficient, or
that legal authorities generally play a minor or dispensable role in all
trade. The historical existence of trading coalitions does not point to a
purely spontaneous and lasting solution to problems of contract
Celebrations of the possibility of property and contract without any role
for the state are not typical of modern legal theory (Collins 1986). The
institutional economist Itai Sened (1995, 1997) has also challenged the
notion of property without the state. Sened (1995: 162) notes:
Like traditional economists, most game theorists systematically overlook
the role of law enforcement.... Many important social institutions do not
emerge as equilibria in games among equal agents, but as equilibria in
games among agents who control old institutions and agents who challenge
such institutions with new demands. In particular, governments play a
crucial role in the evolution of institutions that protect individual
In his extended critique of the notion of property without law, Sened
(1997) argues that true individual rights are established only when a
territorial institution establishes its monopoly over the use of force.
Sened's argument departs significantly from that of Robert Sugden (1986:
5) and others, who argue that legal codes 'merely formalize ...
conventions of behaviour' that have evolved out of individual
interactions. However, to accept the role of the state in the evolution of
property and contract is not to romanticise this institution. Sened sees
the state not as a benevolent and disinterested legislator but as an
institution whose members pursue their own interests.
Sened develops a version of the Hobbesian 'social contract'. This 'social
contract' is not just between individuals in agreeing laws and rights, but
also between the individuals and the state. For Sened, governments weight
the benefits of granting rights against the cost of enforcement. He
Governments do not erect such structures out of benevolence or moral
concern. They grant and protect rights in order to promote their own
interests. But in doing so, they fulfil two crucial social functions. The
function of maintaining law and order that is a necessary condition for
economic growth and affluence, and the function of arbitrage between
conflicting interests. (Sened 1997: 123)
In addition, Sened shows the limitations of the aforementioned type of
game theoretical model involving a few agents. With a larger number of
players it is more difficult for individuals to establish mutual and
reciprocal arrangements that ensure contract compliance. If trading
coalitions do emerge, then these themselves take upon state-like qualities
to enforce agreements and protect property. In a world of incomplete and
imperfect information, high transaction costs, asymmetrically powerful
relations and agents with limited insight, powerful institutions are
necessary to enforce rights. These institutions result from a complex
bargaining process. Sened uses an n-person prisoners' dilemma to show that
the introduction of a government, enforcing rights, can often improve on a
It is an open question as to whether another strong institution, apart
from the state, could fulfil this necessary role. However, it is not to
endorse or glorify the state if we start analytically from the likelihood
and reality that a state will emerge and analyse its possible role on the
process of establishment of property.
Individual property is not mere possession; it involves socially
acknowledged and enforced rights. Individual property, therefore, is not a
purely individual matter. It is not simply a relation between an
individual and an object. It requires a powerful, customary and legal
apparatus of recognition, adjudication and enforcement. Such legal systems
make their first substantial appearance within the state apparatuses of
ancient civilisation. Thus, nearly four thousand years ago, on the famous
stone of Hammuraby, the Ancient Babylonians carved their detailed code of
laws, prescribing penalties and rights. Since that time, states have
played a major role in the establishment, enforcement and adjudication of
At the same time, the development of any state apparatus carries the
omnipresent danger that individual private property would be wilfully
appropriated by the state, perhaps using the ancient norms and precedents
of communal tenure. The state has the capacity to appropriate, as well as
to protect, private property. For private property to be relatively
secure, a particular form of state had to emerge, countered by powerful
and multiple interest groups in civil society. This meant that a
pluralistic state with some separation of powers, backed up by a plurality
of group interests in the community at large. With such a balance of
power, a framework of constitutional law could be established, in which
the interests of both the state and the citizenry could be protected to
some degree. According to this line of argument, the emergence of a
powerful institution like the state is a necessary but not a sufficient
condition for the protection of property and other individual rights.
The aim of this article has been to raise some theoretical questions
concerning the processes of institutional evolution. While Menger's basis
argument concerning the possibility of spontaneous institutional emergence
remains a powerful heuristic, some key problems remain. The first problem
is methodological, and it attaches to any attempt to explain the emergence
of institutions starting from an institution-free state of nature. It has
been argued here that any such attempt is confounded by the unavoidable
necessity of assuming the prior existence of other institutions, such as
language (Hodgson 1998). It is also noted, however, that this problem is
now becoming widely recognised, leading to a significant re-orientation of
the research programme of the 'new' institutional economics. For instance,
a significant feature of the recent work of Aoki (2001) is to take some
institutions as given at the beginning of the formal analysis.
Once it is recognised that human activity can only be understood as
emerging in a context with some pre-existing institutions, then we are
more able to focus on the effects of institutional constraints and
'downward causation' upon individuals, as well as to understand how
interactions between individuals give rise to new institutional forms. The
suggestion here is that the emergence and stability of some institutions
may be enhanced by processes through which institutional channels and
constraints lead to the formation of concordant habits of thought and
behaviour. These arguments point to a more open-ended approach to the
evolution of institutions, downplaying static comparisons in favour of
more processual, algorithmic analyses. In considering an open-ended
evolution of both institutions and individual preferences, such arguments
are redolent of the 'old' institutionalism, although a detailed
specification of the mechanisms of 'downward causation' was often lacking
in that literature. Links are also made with other results that underline
the role of constraints in systemic behaviour, such as Becker (1962) and
Gode and Sunder (1993).
Having pointed to the importance of pre-existing, as well as emerging,
institutions and constraints, the fourth section of this article
considered the possible role of the state in the emergence and maintenance
of some institutions, in particular money and property. It was argued that
reasons for such a role might exist when the institution lacks adequate
inherent self-policing mechanisms. While the discussion here provides
provisional rather than final conclusions, it points to an important
future research programme that will consider in more detail the role and
limitations of the state in institutional evolution.
Strikingly, with the decline of the research programme that attempted to
explain all institutions from individuals in an original, institution-free
'state of nature' , some of the former boundaries between the 'old' and
the 'new' institutional economics have been eroded. In addition,
reconsideration must be given to some of the arguments of the German
historical school, concerning the role of the state in buttressing and
maintaining some institutions. In particular, Sened's (1997) forceful
argument that a state apparatus is necessary to sustain the institution of
property is an unacknowledged vindication of an aspect of the historical
The re-emergence of institutional economics in the final quarter of the
twentieth century is one of the most important and fruitful developments
in social science. It has been the
aim of this article to review some of the more pressing issues of
theoretical enquiry and raise some questions for future research.
1. Address for correspondence: Malting House, 1 Burton End, West Wickham,
Cambridgeshire CB1 6SD, UK. Tel: (44) 1223 290 251.
2. Among a large number of possible examples of this type of approach see
Ullmann-Margalit (1977), Schotter (1981), Hayek (1982) and Sugden (1986).
3. Despite the apparent simplicity of this monetary argument, analyses,
experiments and simulations based upon it are remarkably complex (Jones
1976; Kiyotaki and Wright 1989; Oh 1989; Wa¨rneryd 1989, 1990a,b; Hodgson
1993; Marimon et al. 1990; Duffy and Ochs 1999). Klein and Selgin (2000)
report an apparently successful Mengerian simulation where agents select
the medium of exchange from a set of homogeneous commodities in a Polya
Urn process. Instead of making choices based on preferences, each agent is
obliged to select randomly an exchange medium at each trade. Each
commodity is equally desirable to all agents, equally durable and equally
physically convenient as an exchange medium. The presence or absence of
the double coincidence of wants does not figure in their model. Neither
does a highly desirable commodity that would be perishable or inconvenient
as a medium of exchange. Hence Klein and Selgin give an inadequate picture
of how a monetary unit emerges from barter.
4. The concept of 'reconstitutive downward causation' builds upon the
earlier concept of 'downward causation' in psychology and biology
(Campbell 1974; Sperry 1969, 1991).
5. Bovill (1958) notes that the Moors and Ashanti traded salt for gold
without a verbal language, by placing their products on opposite banks of
the river and withdrawing, taking the merchanidise back if the other offer
was not deemed to be satisfactory. Nevertheless, even in this case there
was a form of communication with shared interpretations and meanings.
Otherwise trade would not be possible.
6. Note that Becker's (1992) definition of habit is very different,
amounting to serially correlated behaviour rather than a programmed
disposition or propensity. 7.
In some respects, this proposed approach is closer to the work of Boyd and
Richerson (1985, ch. 7), where the evolution of a propensity to conform
('conformist genotype' ) is discussed, as well as its effects.
8. For a discussion of the connection of these ideas with recent
developments in psychology see Twomey (1998).
9. For a further discussions of this issue, and the related controversy
between 'Metallists' and 'Chartalists', see Bell (2001), Ingham (2000) and
10. Of course, this does not exclude the possibility of cumulative error
and 'drift' in the evolution of language.
11. However, there has been some limited institutional regulation of
language in France, and spelling reforms have been inaugurated (relatively
successfully) in the Netherlands and (less successfully) in Germany. Much
earlier, after achieving its independence, some changes in the spelling of
English were established in the United States.
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