[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 
Theoretical Research
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 
living together.

[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 
and posthumans.]

Abstract.

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.

1. Introduction

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 
agents.

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 [1909] ) 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 
of institutions.

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' 
without them.

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 
implicitly abandoned.

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 
reality. 5

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 
1998).

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 
Clower 2000).

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 
final term.'

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 
of institutions.

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 
Kenneth Galbraith.

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 
things'.

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 
explained. 7

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 
habits.

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 [1909]: 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 
stage.

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 
enforcement.

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 
rights.

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 
writes:

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 
suboptimal outcome.

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 
property rights.

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.

5. Conclusion

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 
school case.

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


124 HODGSON

aim of this article to review some of the more pressing issues of 
theoretical enquiry and raise some questions for future research.

Notes

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 
Wray (2000).

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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