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chapter 57

..............................................................

WHAT IS MISSING

FROM POLITICAL

ECONOMY

..............................................................

douglass c. north

As the title suggests, this chapter is about what is missing from the literature on

political economy.

The lion’s share of political economy models in both political

science and economics focus on formal institutions in the high-income countries of

the developed West. As many of the surveys in this Handbook attest, this work has pro-

duced elegant models of how legislatures work, how and why bureaucratic delegation

takes place, and why developed countries sometimes choose poor economic policies.

These scholars have also modeled the role of interest groups and, more generally, the

degree to which developed countries redistribute income.

Yet this approach misses a series of bigger questions, the most important of which

is, why aren’t all countries in the world advanced industrialized nations? Why do

legislatures produce relatively secure property rights and the rule of law in the devel-

oped world, but not in the developing world? The answer reﬂects the failure of both

modern economics and political science.

Both economic and political science approaches are built on models with a pow-

erful embedded assumption. This assumption is that developing countries devel-

oped through series of gradual, incremental changes. For example, by adding this

(e.g. democracy) or adding that (e.g. ﬁnancial markets).

History, however, does not seem to present us with a wide spectrum of societies

gradually making a transition from old to new political and economic institutions.

¹ This chapter draws on my recent work with John Wallis and Barry Weingast. See North, Wallis, and

Weing as t 2006.

1004 what is missing from political economy

Historically, social systems have persistently limited entry into political and economic

activities. The economic and political rents created by limited entry have been the glue

holding social systems together. Providing for social order by limiting entry, however,

has come at an increasingly high cost.

Over the last three centuries, a handful of societies have made a transition to open

access political and economic systems. In reality, these systems enjoy a greater degree

of internal competition. This competition corresponds to the theoretical constructs of

democracy and civil society created by political scientists, and theoretical models of

competitive markets created by economists. These societies are called open access

orders because they allow open access in both politics and economics: in politics,

there is open entry into politics, competition for political power, and all citizens have

rights by virtue of being citizens; in economics, there is open entry into markets, and

markets are competitive rather than systematically restricted by the state.

We have begun to understand how open access societies work to produce better

deﬁned and enforced political rights and more productive economic systems. But we

are far from understanding how a social order makes the transition from limited to

open access.

In short, we have yet to ﬁgure out what makes the non-developing countries so

stable that, even with a generation’s worth of the best advice and substantial aid,

few developing countries are signiﬁcantly further down the road of political and

economic development than they were in 1980. Moreover, those states that have made

signiﬁcant progress—such as Korea, Taiwan, and Singapore—have not done so by

taking the advice of development specialists.

The current state of political economy theories and applications is lacking in two

areas. First, they do not adequately address the problem of non-incremental change.

Second, they do not take into consideration the nature of human cognition. Each of

these omissions is addressed in turn.

1 The Need for a Dynamic Theory

.............................................................................

A natural starting point for social science theories is to assume that today’s world

looks pretty much the same as yesterday’s world. We implicitly assume that we live in

an ergodic world, that there is a fundamental underlying structure to the world that is

stable and that we can ﬁgure out. This assumption implies that changes in the world

around us occur incrementally, at the margin.

The incremental approach to economic reform is wrong. Instead, development re-

quires that a country change its entire structure. Theoretical political economy needs

to address this question: what is the structure of developing countries that makes

them so stable? Only then can you begin to understand how you might change it.

Incrementalism also fails to explain history. History doesn’t repeat itself. In-

stead, polities and economies are continually evolving. This point doesn’t imply that

douglass c. north 1005

political and economic theories are wrong, but that they cover a subset of the problem

of the evolution of societies over time. We must recognize that the non-ergodic nature

of the world implies that it cannot be modeled completely in the standard way.

The non-ergodic nature of the world causes problems for humans. The brain

consolidates information from the past based on pattern-based reasoning.

In novel

situations, individuals look for patterns from their experience to apply to the new

situations. In truly novel situations, individuals are likely to misunderstand what

they are seeing—e.g. apply a pattern from the past that turns out, ex post,tobe

inappropriate to the new situation.

The emergence of open access orders in a few countries over the last few centuries

is a prime example of the non-ergodic nature of social change. Individuals in open

access societies assume that competitive forces will produce market prices that can

be relied on and governments that they can trust (at least in relative terms). One of

the main results of the growing cross-country growth literature in both economics

and political science is that citizens “trust” their governments and social institutions

much more in the developed world (e.g. Knack and Keefer 1995).

How are we to account for the change from a social equilibrium in which individu-

als rationally trust neither the economic nor the political institutions they live under

to one where open access institutions enable individuals to trust in viable and fair

social outcomes?

The main implication is that solving novel problems requires that economic and

political actors must be self-aware of what is happening to them. In truly novel situa-

tions, where past patterns and solutions cannot work, the only path to a solution is a

dynamic one involving trial and error and feedback in an attempt to ﬁnd something

that works; in a word, fumbling. There is no alternative. This is why Hayek’s adaptive

eﬃciency is so important.

2 The Centrality of Beliefs

and Learning

.............................................................................

The dynamic nature of history implies that the centrality of beliefs—how humans

form their beliefs and how they learn (North 2005)—is fundamental to a new social

science. This in turn leads us to two enquiries: ﬁrst, how the mind and brain work

to understand the environment; second, how humans learn from one another, for

example though culture.

We also need to understand that studying the mind is not like studying the physical

sciences—“it’s all in your head” as they say. This makes all knowledge, at least at the

ﬁrst step, subjective. But lest you think we’re going in the direction of postmodernism,

we’re not. Social scientists try to test their theories. But even the tests have subjective

²North2005 elaborates on this theme.

1006 what is missing from political economy

elements, because they are in your heads. This doesn’t make it postmodern, but that

the social sciences are more imprecise than the sciences. Understanding these limits

is a necessary ﬁrst step toward understanding what social sciences can do.

So a beginning requirement is understanding how the mind and brain work. How

we translate evidence from the exterior world through the senses and combine it with

beliefs and previous knowledge to create explanations for the social science world.

Social science has an advantage: we have explicit tests of logic and evidence. This

implies we should do a better job, but not always.

Beliefs also require that we consider learning: We learn both from the environment

and from each other. The latter includes culture, the accumulated beliefs and inher-

ited institutions from the past that provide the framework within which we begin

thinking about problems.

In some situations, we are exposed to new ideas and experiences, and some of the

latter force us to think diﬀerently. We have no good theories about how humans form

beliefs, how we evolve existing patterns of understanding into new ones. Hence we

have only the rudiments of the tools needed to study the problem of behavior in the

face of novel problems.

This process is never automatic, and many societies fail to resolve the new chal-

lenges they face.

3 Three Applications

.............................................................................

Consider three examples. In the early 1760s, American colonists had lived within the

British Empire for over a century and considered themselves British.

To the extent

that Americans thought about the metropole, it was that Britain was a benign, if re-

mote, presence. Although Britain controlled the system-wide policies of the empire—

trade and security—Americans exercised self-government for nearly all domestic

aﬀairs, including property rights, social policy, religion, economic regulation, and

the enforcement of contracts. Nothing in the American experience suggested

otherwise.

And yet events over the dozen years after the end of the Seven Years War in

1763 shocked Americans because they were inconsistent with these long-held be-

liefs. For the ﬁrst time, Britain sought to make domestic colonial policy. Many of

the initial policies, such as the stamp tax, were relatively trivial in magnitude. But

some colonists—those who later became radicals—declared that these policy changes

represented a fundamental sea change in British attitudes and intentions.

Drawing on the Whig tradition in seventeenth-century England, the theory of the

British constitution that dominated among the colonists held that practice enshrined

over the generations attained constitutional status (Greene 1986;Reid1995). This view

³ This example draws on Rakove, Rutten, and Weingast 2005.

douglass c. north 1007

implied that acquiescing in the British attempt to impose the stamp tax—no matter

how trivial in itself—gave them the right to impose any policy. To many radicals, this

implied that Britain sought to undo the credible commitment to honoring American

property rights: In short, the British had become a great threat. The radicals read

malevolence into British behavior—Great Britain was out to subjugate the American

colonies.

In the mid-1760s, most Americans did not agree. Although they did not approve of

the British behavior, they did not see it as the beginnings of malevolence and subjuga-

tion. Nothing in their previous experience suggested anything like what the radicals

were suggesting. And yet, nothing in their experience allowed them to understand

what the British were doing and why they were doing it.

In the face of their failure to convince most Americans, the radicals made a predic-

tion: the British would attack the source of American liberty, the colonial assemblies

that had protected their rights. Indeed, the British did just that. In the face of New

York’s refusal to quarter British troops, Britain suspended the New York Colonial

Assembly. A few years later, when Americans in Boston dumped tea in the harbor to

protest the British, reaction was far more forceful, passing what became known in the

colonies as the Intolerable Acts. These closed the port of Boston, imposed martial

law, and annulled the Massachusetts Colonial Charter. In short order, the British

had acted exactly as the radicals had predicted: they had disbanded the Colonial

Assembly and with it Massachusetts law protecting colonial property rights. Pivotal

moderates became suﬃciently convinced of British malevolence that they supported

arevolution.

The point of this example is that Americans faced a problem that was unique

given their experience. Nothing from the past allowed them easily to interpret this

challenge. Initially, most people thought the problem relatively small while a smaller

group argued that it represented the end of the world as they had known it. As the

colonists and the British interacted, more evidence was produced, eventually leading

asuﬃcient coalition to support a revolution. Even so, most Americans could not be

sure a war was necessary.

Second, consider Timur Kuran’s (1992) brilliant point in his essay “Why revolutions

are better understood than predicted.” The idea is that in authoritarian regimes (think

of Poland in the 1970s), most citizens hate the regime and, moreover, this is common

knowledge. And yet each citizen knows that if she acts alone against the regime, she

risks severe punishment. Only if a great many citizens act in concert do they have a

hope of overthrowing the regime. This is a coordination game; speciﬁcally, a tipping

game.

Authoritarian regimes understand this strategic environment, so they spend a large

portion of their resources suppressing the ability of citizens to coordinate. These

regimes typically drastically curtail the freedom to speak, to assemble, and to form

organizations. As Kuran observes, the regime acts to defend against all actions that it

can reliably predict will foster citizen coordination.

This point implies that the only events that can spark citizen coordination are those

that the regime fails to recognize for what they are. In other words, revolutions cannot

1008 what is missing from political economy

be repeated: smart authoritarians will defend against means for coordination used in

previous revolutions.

Third, 9/11 dramatically transformed the United States’ view about its security and

vulnerability. The solution to this new form of terrorism is not obvious at this point.

Although not likely, it is possible that the rise of terrorism over the coming decades

will dramatically transform the developed world, shrinking economies. At the current

moment, policy-makers have no real idea how to solve this problem, indeed, whether

or not there is a solution to this problem.

These examples illustrate several points. First, they demonstrate the need for a dy-

namic theory of the world. Major events in history—perhaps all major turning points

in history—occur when a novel issue arises where existing patterns of knowledge are

inadequate to understand the world. In each of these examples, a society faced a novel

problem where the solution was not obvious, and, in the case of Kuran’s revolutions,

not even recognized as a problem.

Second, existing theories are useful because they help us learn about human nature

(for example, that politics typically involves a mix of self-interest and the importance

of beliefs) and about basic principles that hold under all circumstances (such as

the principles of economics). But these lessons are about a subset of all problems. The

non-ergodicity implies novel problems are always emerging, necessarily that existing

“lessons” are inadequate guides. This forces us to ask a much tougher question: how

are we evolving and can we understand novel change in the world? This requires that

we have a theory about the dynamics of the process of change, which we do not have.

4 Conclusions

.............................................................................

We have an inadequate understanding of why the developed world is developed;

how it made the transition from non-developed countries to developed ones; why

it can sustain democratic constitutions; and why both economic development and

democracy typically fail in the so-called developing world. This chapter argues that

the failure to understand these fundamental questions reﬂects that social science fails

to have a truly dynamic theory that takes into account the non-ergodic nature of the

world.

References

Greene,J.P.1986. Peripheries and Center: Constitutional Development in the Extended Polities

of the British Empire and the United States, 1607–1788.NewYork:Norton.

Knack,S.,andKeefer,P.1995. Institutions and economic performance: cross-country tests

using alternative institutional measures. Economics and Politics, 7: 207–27.

Kuran,T.1992. Why revolutions are better understood than predicted. Contention, 1: 199–207.

douglass c. north 1009

North,D.C.2005. Understanding the Process of Economic Change. Princeton, NJ: Princeton

University Press.

Wallis,J.J.,andWeingast,B.R.2006. A framework for understanding recorded

human history. Unpublished working paper, Hoover Institution, Stanford University.

Rakove,J.,Rutten,A.,andWeingast,B.R.2005. Ideas, interests, and credible commitments

in the American Revolution. Working paper, Hoover Institution, Stanford University.

Reid,J.P.1995. Constitutional History of the American Revolution, abridged edn. Madison:

University of Wisconsin Press.

chapter 58

..............................................................

MODELING PARTY

COMPETITION IN

GENERAL

ELECTIONS

..............................................................

john e. roemer

1 Introduction

.............................................................................

Popular elections are the central political act of democracies,

and citizens in all

advanced democracies organize their political competition through parties that com-

pete in general elections. While political historians have studied parties for many

years, it is remarkable that only in the last decade or so have there been seri-

ous attempts at abstract conceptualizations—that is, formal models—of inter- and

intraparty competition in a democracy. In this chapter, I will report on the attempts

to model political equilibrium among parties and its applications. Indeed, it ap-

pears that a satisfactory model of interparty competition can only be constructed

by paying careful attention to intraparty competition between conﬂicting interests or

factions.

In the advanced democracies, between 27 and 50 per cent of the gross national

product is collected through taxation and disbursed by the state, and state policies are

decided, ultimately, by popular elections. We no longer view the state as a benevolent

social planner, which maximizes some social welfare function whose arguments are

the utilities of its citizens; rather, in the new political economy, the state is pictured as

¹ After William Riker 1982.

john e. roemer 1011

implementing the favored policies of whichever coalition of citizens manages to win

control of it. (In one extreme view, that coalition could be the bureaucrats who run

the state.) Thus, the theory of political competition should be, and is becoming in

fact, a sub-ﬁeld of public economics.

Furthermore, the issues with which the state deals are myriad, involving law, reli-

gion, language, and ethnic and racial conﬂict, as well as traditional economic issues

of taxation and the provision of public goods.This means that any realistic theory of

political competition must represent parties as taking positions in a multidimensional

policy space.

Yet the most commonly used theory of political competition, of Harold Hotelling

(1929), later elaborated by Anthony Downs (1957), with its principal result, the so-

called median voter theorem, posits unidimensional political competition. More-

over, many believe that the Arrow impossibility theorem tells us that there can be

no theory of multidimensional political competition—that there is no satisfactory

procedure whereby citizens can aggregate their preferences to decide upon which

multidimensional policy will be implemented. Our aim in this chapter is to rectify

these Downsian and Arrovian pessimisms.

We will begin by introducing some notation, and then proceed to a review of

the two main theories of political competition when it is assumed that the policy

space is unidimensional. We will then note the problems involved in generalizing

these theories to the multidimensional context, and propose a resolution to these

problems, a theory of multidimensional political competition. Finally we will discuss

some applications of this theory, and pose some open questions.

2 The Political Environment

.............................................................................

We model a polity as follows. There is a policy space T,asubsetofsomen-dimensional

real space. There is a set of voter types,denotedH, which is a sample space endowed

with a probability measure F.Avoteroftypeh has preferences over the policy space

represented by a utility function v(·; h), on T.

In the simplest economic application, we might think of h as describing a citizen’s

income or wealth and her preference for public goods, and T as a set of vectors each

of which speciﬁes some tax policy and supply of public goods. Given any tax policy t,

the voter’s after-tax income will be determined, as will be the supply of public goods,

engendering a utility level for this citizen. v(t; h) is the utility citizen h enjoys at policy

t; the function v is thus an indirect utility function, derived from the citizen’s direct

utility function over consumption of private and public goods.

Suppose the voters face two policies, t

and t

.Thesetofvotertypeswhoprefer

theﬁrstpolicytothesecondisdenoted:

W(t

, t

)={h|v(t

, h) >v(t

, h)}.