Three Lessons on Institutions and Incentives (Part 7): Breaking the mold

This role of entrepreneurs also depends on an abstract characteristic of technological knowledge: it works in a manner contrary to that of most goods, since it is more productive to the extent that it is more widespread in the population. This characteristic of the abstract nature of technological knowledge is related to the phenomenon of the combination of skills (matching of skills): the negative side of creative destruction lies in substitution phenomena (a computer program of inventory management increases the productivity of work saving the salaries of the army of employees who used to carry them with pencil and paper), but the positive side comes from the phenomena of complementarity.

As William Easterly exemplifies, the cardiac surgeon will be more productive in a first world hospital, where he will have specialized nurses, other qualified doctors like him, a sophisticated system of hospital administration, and so on, being the only cardiac surgeon in a hospital. city ​​of the third world, where it does not have professionalized nurses, nor the help of other medical colleagues, working in a hospital in which he himself has to deal with administrative issues. If there were only substitution relations, it would be convenient for a doctor to practice his profession in the most remote place possible. However, as relations of complementarity of knowledge exponentially increase the productivity of the professionals involved, the doctor will find it more convenient to practice in a health center that has the largest number of doctors and paramedics possible.

The latter does lead to the phenomenon of “traps”: any rational agent, who maximizes the utility of their choices will be discouraged to deepen their studies if they perceive that they can not give any use to their education. There are the cases in which a person discovers that in his country there is no technology or the necessary number of professionals to develop a specific activity, or that, existing, you will find prohibited the exercise of their profession based on restrictions regarding their race, caste, social class, sex, etc. Since, rationally, a person who is included in a particular group under which he will be found forbidden or will be hindered the exercise of his profession, he will find as the most rational of their alternatives to abandon their studies, so that their chances of progress will no longer be limited only by legal or social barriers, but because of their lack of suitability for high-paying functions. Such are the so-called “poverty traps.”

There are also wealth traps. There are those cases in which the individual knows that he is within a favored group or in which he knows a large number of professionals and, therefore, invests time and money in his education because he knows that he has high chances of success, which will then be confirmed. Obviously, such phenomena of divergence generates another problem, addressed both by Easterly and by Daron Acemoglu & James Robinson, which is that of polarized societies.

Easterly affirms that it is the exchange of goods and services, through the mutual benefits that they report to the parties that participate in it, the main source of wealth generation. Where individuals are allowed to exchange, in a stable institutional framework with a stable currency, is where prosperity flourishes. However, Easterly recognizes that bad luck can devastate nations, as are the cases of geological and climatic phenomena such as earthquakes, tsunamis or mudslides, as well as recognizing that the situations of individuals involved in a poverty trap can only be resolved through an active public policy that not only provides education, but also establishes the conditions so that the recipients of that educational system can count on certain expectations that they will be able to apply that knowledge acquired through education and that, consequently, it is reasonable to study.

Just as the bad star can affect the economic performance of the countries, so can a favorable conjuncture, such as the case of a transitory improvement in terms of exchange of a given country. But this favorable circumstance can become a counter-march. Easterly explains that, for a simple statistical matter, it is very difficult for both a nation and an individual to always remain on the crest of the wave, over the years everything tends to return to the average. The problem occurs when a country -or a person, too- got used to a certain level of spending in the boom years and intends to maintain it through debt or emisionism. We come to the cases in which, according to Easterly, the government can “kill the growth.” Public debt and inflation generate capital consumption and, consequently, poverty.

Another way that governments have to discourage growth is through corruption. Not only because it means a transfer of resources from productive activities to unproductive activities, but because it also means a bad signal for citizens. However, in cases of corruption, as noted above, wealth at least changes hands. There is another case, even more pernicious, in which the government’s actions, whether motivated by corruption or inspired by good intentions, destroy wealth, without even redistributing it: this is the case of inconsistent public policies derived from highly polarized societies.

Public policies that aim to favor a given industry, but at the same time need to agree on measures with other sectors of the economy, whose purpose is to compensate for the losses generated by those policies, can lead to a tangle of inconsistent regulations that, instead of transfer riches from one sector to another, directly destroy them. For example: exchange controls harm the export sector, since they generate black markets. The exporters will have costs that will be partly quoted according to the black market prices (which are higher) and they will have to liquidate the value of their exports at the official exchange rate, which will be lower. Regulations of this kind may not involve acts of corruption, but they do destroy wealth, which there is no way to recover.

Easterly lists numerous examples of everything that needs to be done to destroy growth. However, there is something that deserves to be especially highlighted: the progress or stagnation of nations does not depend on educational, cultural or geographic factors, but rather on the incentive framework that predominates. This incentive framework will always be abstract, that is, it can be applied at any time and place.

[Editor’s note: Here is Part 6, and here is the entire, Longform Essay.]

Three Lessons on Institutions and Incentives (Part 6): Breaking the mold

Daron Acemoglu & James Robinson acknowledge that the weakest point of their theory consists of recommendations to “break the mold.” How to change the historical matrix that leaves the nations stagnant in extractive political and economic institutions, or that move them back from having inclusive economic institutions with extractive political institutions to being trapped in exclusively extractive institutions with the risk of falling into a failed state. This brings us to Douglass C. North and his theory of institutional change.

Although he published works before and after Institutions, Institutional Change and Economic Performance, this book can be taken as the archetypal expression of neo-institutionalism. In the United States, institutionalism, whose main speaker was the Swedish immigrant Thorstein Veblen, was the local expression of what in Europe was known as “historicism”: a romantic current, inspired by Hegelian idealism, which denied the universal validity of institutional rules and claimed the particularism of the historical experience of each nation. American historicism was called institutionalism, because it concentrated the sciences of the spirit in the empirical study of the institutions given in the United States.

On the contrary, North’s school is called “neo-institutionalist” because it does exactly the opposite: it studies the phenomenon of institutions from a behavioral point of view and, therefore, universal. As already noted here, for North institutions are limiting the choice of the rational agent in his context of political, economic and social interaction. These limitations are abstract; that is, they are not physical, like the law of gravity, nor do they depend on a specific and specific order of authority. Examples of these abstract limitations can be found in social customs and uses, in moral rules, in legal norms insofar as they are enunciated in general and abstract terms.

Attentive to such diversity, Douglass C. North groups institutions in formal and informal. Within the formal institutions we find, unquestionably, the positive law, in which its rules of formation and transformation of the statements that articulate them can be identified very clearly. In a modern democracy, laws are sanctioned by the legislative body of the State. Meanwhile, the rules of formation and transformation of statements concerning morality are more diffuse – previously, Carlos Alchourrón and Eugenio Buligyn, in Normative Systems, had used this distinction to support the application of deontic logic to law, since deontic statements of law are much more easily identifiable than those of morality.

On the other hand, North distinguishes two types of institutional change: the disruptive and the incremental. An example of disruptive institutional change can be a revolution, but it can also be a legislative reform. The sanction of a new Civil Code, entirely new, can mean a disruptive change, while partial reforms, which incorporate judicial interpretative criteria or praetorian creations, can be examples of incremental changes.

Institutional changes do not necessarily have to come from their source of creation or validity. Scientific discoveries, advances in transport and telecommunications, information technologies, are some of the innovations that can make certain institutions obsolete or generate a new role or interpretation for it, depending on the open texture of the language.

Therefore, following the tradition of Bernard Mandeville and Adam Ferguson, neo-institutionalism admits that there are unintended consequences in the field of institutional change. Not only the incremental change of institutions, be they formal or informal, depends largely on changes in the cultural and physical environment in which institutions are deployed. Also the disruptive and deliberate change of a formal institution can generate unforeseen consequences, since it is articulated on a background of more abstract informal institutions.

Both Acemoglu & Robinson and North acknowledge that there is no universal law of history that determines institutional change -i.e., they deny historicism, as Karl R. Popper had defined it at the time-; what we have, on the other hand, is an “evolutionary drift,” a blind transformation of institutions. In this transformation, political will and environmental conditions interact. The latter not only limit the range of options for the exercise of “institutional engineering,” but also introduce an element of uncertainty in the outcome of such institutional policies, the aforementioned unintended consequences.

Much more complex is to identify which components are included in that black box that is called “environment” (environment). In principle, there could reappear the creatures that both William Easterly and Acemoglu & Robinson had banished from their explanations: the geography, culture and education of the ruling elites; more sophisticated elements such as the one referred to in the previous paragraph could also be incorporated: technological change. However, the discoveries of science would have no impact if the institutional framework pursued “creative destruction”, seeking to protect already installed activities from competition, or a lifestyle threatened by technological innovation.

We arrive here at a seemingly paradoxical situation: the institutions’ environment is the institutions. Using the Douglass North classifications system, one could try as a solution to this paradox the assertion that formal institutions operate on the background of informal institutions, which escape political will, and that disruptive institutional changes occur in a context of other institutions that are transformed in an incremental way. From this solution to reintroduce culture as a factor of ultimate explanation of institutional change, only one step remains.

At the other extreme, following the typologies used by Acemoglu & Robinson, the institutions can be political or economic and these in turn can be extractive or inclusive, jointly or alternatively. Inclusive economic institutions within a framework of extractive political institutions can result in a limitation of creative destruction and, consequently, produce a regression to extractive economic institutions. In the institutional dynamics of Acemoglu & Robinson, history can both progress and regress: from economic institutions and extractive policies it can be involuted even to situations of failed state and civil war. To reach the end of history, with inclusive institutions, seems to depend on the conjugation of a series of favorable variables, among which is the political will; while to fall back into chaos and civil war it is enough to let go. Without looking for it, the conceptual background of Why Nations Fail rehabilitates the thesis of Carl Schmitt insofar as it presupposes that in the background of human interaction there is no cooperation but conflict.

For his part, William Easterly in The Elusive Quest for Growth does not ask these questions, but simply works under a hypothesis that already has it answered: whenever there is human interaction, there will be a framework of incentives and such a framework of incentives will have certain universal characteristics. Douglass C. North’s central concern in Institutions, Institutional Change, and Economic Performance, as well as that of Acemoglu & Robinson in Why Nations Fail, was to establish patterns of events and conditions that made some nations be prosperous while others could not emerge from stagnation. That is, they are works that must necessarily be about the differences between one country and another and, therefore, emphasize the different conditions. Notwithstanding that both North and Acemoglu & Robinson expressly shun culturalist explanations, but instead postulate abstract models and typologies of institutions and institutional change to be applied universally, when the moment of exemplification arrives, they must necessarily resort to the differences between countries and regions. While it is true that both books resort to the description of the problems of the southern United States when illustrating how certain institutions generate results similar to those of third world countries, the culturalist explanation is always available.

In contrast, William Easterly in his The Elusive Quest for Growth: Economists’ Adventures and Misadventures in the Tropics focuses almost exclusively on countries with low economic performance and only tangentially refers to cases of high performance. Therefore, in his work, the empirical analytical tools used to dissect it are well separated. To do this, Easterly will not only use a utility-maximizing rational agent model, but will also enunciate abstract models of universally valid human interaction.

In the first part of the work, Easterly describes the failed panaceas of growth: direct aid, investment, education, population control, loans to make adjustments and subsequent debt forgiveness. Affirms that such policies invariably failed because they did not take into account the basic principle of the economy that indicates that people respond to incentives (people respond to incentives, a statement that is repeated as a mantra throughout the book). While acknowledging that in some cases of extreme poverty and bad luck it is necessary for governments to take direct action to help people escape from poverty traps, the author proposes as the main means for people to take a path of prosperity: work to establish the right incentives. It clarifies, however, that this should not be a new panacea but a principle to be implemented little by little, displacing the layers of vested interests impregnated with the wrong incentives and allowing the entrance of the right incentives.

These incentives, right or wrong, do not depend on the culture, nor on the education of the elites, nor on geography. On the contrary, they consist of abstract models of human interaction, which can materialize at any time or latitude. Since the main interest of The Elusive Quest for Growth is, precisely, growth, such models concern this matter, but nothing prevents future research from identifying other abstract patterns of behavior that allow us to infer incentives to address other issues, such as crime, equity, violence, etc.

Some incentive structures that Easterly describes in relation to the problem of growth are the following: conditions for increasing returns – instead of decreasing ones – that come from technological innovation, which in turn depend on phenomena identified as “leakage of technological knowledge” (leaks of technological knowledge), “combination of skills” (matches of skills) and traps (traps) of poverty -although there are also wealth traps.

Technological knowledge has the capacity to filter into a population because it is mainly abstract. It can be exemplified in an accounting system, the practice of carrying inventories, literacy, techniques and procedures for the production, distribution and sale of products, etc. If the technological knowledge consisted exclusively of physical machinery, then yes it would be to a point where yields would become decreasing. On the contrary, understanding technological knowledge as consisting of “abstract machines”, it acquires the characteristics of a public good: it is not consumed with its use nor can it be exclusive. This is how technological knowledge can be extended in a society, multiplying the productivity of its members without entering into diminishing returns.

Also, following the ideas of the recent Nobel Prize in Economics Paul Romer, Easterly highlights that technological change can generate increasing returns thanks to the work of an endogenous agent of the economy, the entrepreneur. Being the labor force a fixed factor of production with respect to machinery, it is expected that, at a certain point, capital will generate diminishing returns, thus conditioning the growth rate of an economy (the main concern of The Elusive Quest for Growth). For its part, the entrepreneur is not only that agent of the economy who discovers new business, he also discovers new uses for existing capital goods. Easterly does not mention it, but this is also the main conclusion reached by Ludwig Lachmann in his work Capital and Its Structure. This work of the entrepreneurs, to find a new utility for a set of capital goods that had come to generate diminishing returns, making them continue to generate increasing returns is what frees the rate of growth of the economy from the limits of technological change and, in turn, makes it depend on the endogenous factor of the economy: the incentives for entrepreneurs to develop their activity -which some call creative destruction.

[Editor’s note: Here is Part 5 and here is the entire, Longform Essay.]

Three Lessons on Institutions and Incentives (Part 5): “Spontaneous” institutions

When Friedrich A. Hayek referred to the coordination problems among rational agents as a consequence of the dispersion of information in the economic system -and that made him worthy of the Nobel Prize in Economics- he did not refer to an information problem that could be solved with better statistical tools. This is also a problem of the economics of information and what Hayek himself called “limit relative to knowledge,” since the frontiers of science could be continuously extended, generating more and more information. The limit that Hayek qualified as absolute for knowledge came from the increasing degrees of abstraction and complexity characteristic of any “extended society.” This to the point of calling such phenomena spontaneous orders, or abstract or extended. Such orders allowed the prediction of the general configuration of the system, but they made impossible the concrete prediction regarding the relative position of each particular element of the system. If one looks for an example of such an institutional arrangement, Hayek himself would point as such to the legal systems that structured the mercantile communities, not because they lacked legislation or a state that monopolized its enactment, but because it provided the members of such a mercantile community of a dispute resolution system whose complexity acted as a guarantee of impartiality.

There is much talk of the virtues of institutions as guarantors of predictability, or legal security, or political stability and clear rules of the game. All of them are positive qualities that express the favorable consequences of a negative quality -negative not in the sense of pernicious, but of absence of a particular characteristic- that can be defined as “absence of arbitrariness.” In general, the concept of freedom is related to that of “free will,” which is very desirable for those who exercise it, but it could become a hell for those who suffer the free will of a third party. The institutions are, as it was pointed out, abstract limitations to the social human action that are structuring of the political, economic, and social interaction; in other words, they limit the arbitrariness of the decisions of own and third parties.

In a certain sense, institutions limit individual freedom, whether we define it in a positive way -as the faculty to exercise its own free will in a legitimate way- or negative -like the absence of coercion to exercise one’s free will. However, for the definition of freedom as absence of domination or absence of arbitrary coercion (similar to that coined by Quentin Skinner), institutions cease to be limiting of individual freedom to be functioning as the abstract devices that make it possible.

An institution is made up of a set of rules that not only limits the action of the rational agent and the action of a third party, but also limits, fundamentally, the actions of the political authority. The said procedural due process, for example, belong to the category of institutions that limit governmental action: no one can be punished except by a judgment based on a law prior to the fact of the process and dictated by its natural judges. The due process is not exhausted in this formulation, but this already constitutes in itself a strong restriction to the power of the government over the citizens. These limits make foreseeable the actions of the government that can interfere in the free will of the individuals and, therefore, define their spheres of autonomy.

Of course, although an institution by itself provides stability and predictability to the system and this generates dividends in terms of the coordination of expectations and individual plans, not all institutions are equally efficient if the mentioned predictability is taken as an evaluation parameter. A system of multiple castes, for example, depends on numerous but ambiguous indicators for the identification of each individual, necessary for the purpose of determining what rights and obligations that person owns. In contrast, a modern system, at the other end of the arch, which equates, with the exception of certain political rights, citizens with inhabitants, and agrees equal rights and obligations for anyone who proves distinctive features of humanity, drastically reduces the “transaction costs” of a system of social control structured around abstract institutions.

The summum of arbitrariness can be identified in despotic systems, in which the free will of the ruler or the group of rulers finds no abstract limit in the law -only concrete limits of other more powerful ones. In these systems, the rules are mere orders to the subjects that have a changing and unpredictable content. In any case, if there are positive laws, we are not facing the rule of law, but government through law. When a case of such extreme arbitrariness is exercised from one man to another, we call it slavery or, in the best of cases, servitude.

At the other pole of the arch we have, as has been pointed out, the modern system, which recognizes in each individual the inalienable right to exercise his free will within a sphere of autonomy that is equal for all. Thus, in a system of isonomy, knowing the limits of the sphere of autonomy itself, the limits of the spheres of autonomy of the third parties are known and, consequently, each individual can form expectations regarding a range of expected behavior of his fellows. They will have a high degree of certainty, as will their respective plans.

In the middle of the two poles of these two ideal types of legal-political systems we have the range of possible and specifically given societies, in which freedom as absence of arbitrary coercion (in the meanings given by both Skinner and Hayek) verify to a greater or lesser extent. What Daron Acemoglu & James Robinson do in this regard, is to open two axes of institutional analysis: the political and the economic, and in turn introduce the distinction between extractive and inclusive institutions. Extractive institutions would be halfway between despotism and isonomy: there are limiting rules of free will, but they are not equal for all, fundamentally restricting the right to access certain prerogatives: limitations on access to food, of political decisions or legal monopolies, to cite examples.

It is worth remembering that the birth of individual rights took place, primitively, as prerogatives that the powerful took from the despot. Such is the case of the Magna Carta of 1215. That is why it is said that rights do not pre-exist the individual but that they are conquered. These prerogatives that were pulling the sovereigns one by one and that is why there is no talk of “liberty” in the singular, but of “liberties”: of trade, of industry, of speech, of transit, etc. These prerogatives or liberties were initially torn from the ruler by militarily or financially powerful men and then extended to the rest of the inhabitants, to the point of recognizing their ownership every human being. Correlatively, by virtue of this process of institutionalization, in which each new prerogative was taken from the ruler, this implied a new limit to governmental power, so that the political system was evolving from tyranny to a constitutional system.

Following the course of this evolution, Acemoglu & Robinson work with the ideal substitute types of “failed state” and “modern state,” the complementary ideal types of “political institutions” and “economic institutions” and again with ideal substitute types of “extractive institutions” and “inclusive institutions.” Political democracy, with a plurality of voices and the extension of political rights, as to elect and be elected to public office, means the realization of inclusive political institutions. An economy that enjoys of sound money, a balanced public budget, openness to international trade, free access to markets, absence of legal monopolies and regulation of natural monopolies is the example of what inclusive economic institutions mean. For all this, we need a degree of political centralization crystallized in the modern state, which enforces the law, whose prescriptions must establish a public sphere whose administration the rulers must be accountable of.

Obviously, the analytical instruments of Acemoglu & Robinson are useful both in political and economic liberalism and, although they do not make a total use of almost three centuries of doctrinal and philosophical elaborations, their classification system is susceptible of being deepened by the incorporation of such concepts. For example, on the end of Why Nations Fail, the authors are at the crossroads of answering the question that serves as the title for the work. For this, they allude to the fact that certain critical situations cause a country to take one or another path: the development of inclusive political and economic institutions or the fate of stagnation, but that there is no such thing as a general law of history that determines that one or the other path will be taken forcibly at some specific historical moment.

This is how the authors invoke, timidly and tangentially, the current of cultural evolutionism, according to which the social customs and habits are evolving following the changes in environmental conditions, but without having a predetermined course, following an evolutionary drift. In the same way, they could have explained the institutionalization that the emerging state implies a modern state through the names and procedural principles that are previously in the uses and customs that make up private law. This is how Max Weber explained it and such studies can be used to delve into the historical analyzes formulated by Acemoglu & Robinson when answering why countries fail.

Notwithstanding this, these economists do establish certain patterns of institutional evolution that are apt to be applied when designing public policies or, plain and simple, a government program. In this sense, they allude to cases such as those of Argentina in the late nineteenth and early twentieth centuries, which had a resounding success at the moment of formal institutionalization through the enactment of a written constitution and the establishment of a central government of a federal nature. As explained by Acemoglu & Robinson, Argentina incorporated inclusive economic institutions, while it was slower to leave behind extractive political institutions. Initially, Argentina was strongly benefited by the “catch up” regarding the degree of progress of its economic partners, mainly England.

However, following these evolutionary patterns, sooner or later a crucial point is reached in which, in order for the economy to continue to progress, higher levels of competition must be developed that make it necessary to tolerate the impact of the so-called “creative destruction.” When the political system is extractive, it is much easier to resist innovation in the economic sphere when it threatens their economic rents. Arriving at that stage, there are the conditions given for the economic and political progress of a country to be reverted to extractive economic institutions.

That is to say, with inclusive institutions, both politically and economically, it becomes more difficult to find shortcuts to the sectors threatened by the creative destruction of all innovation that progress brings, in order to neutralize it. Once the regulatory, interventionist and protectionist apparatus that characterizes the extractive economic institutions is assembled, the contest moves to the political level: whoever has the springs of political power will distribute the benefits of the economic system. If we add to this a polarized society, it is not difficult to explain why the alternation of popular governments emerged from popular democracies and military civic coups. Specifically, in the case of Argentina, Acemoglu & Robinson add the factor of justice: for a country to be involved in such a spiral of institutional involution, it was necessary for justice to lose its independence from political power.

[Editor’s note: Here is Part 4; here is the entire, Longform Essay.]

Three Lessons on Institutions and Incentives (Part 4): Institutions and the Rule of Law

Daron Acemoglu & James Robinson call the set of regulations that obstruct innovation “extractive institutions.” Of course, here again, extractive institutions are less harmful than the total absence of institutions. Not every change in the status quo can be interpreted as “creative destruction” or “entrepreneurship.” As Friedrich Hayek pointed out in Law, Legislation and Freedom, so that the most mutually compatible plans can be carried out, it is necessary that a well-defined set of expectations be systematically frustrated: the usurpations, the frauds, collusions, the paramilitary bands, etc., etc. The main thing is to have institutions that guarantee a minimum of order. Now, many times the institutions manage to be put into effect as a result of having the consensus of a certain number of interests that see in the law an opportunity to extract benefits. It is the distinction between Acemoglu & Robinson between the already mentioned “extractive institutions” and “inclusive institutions.” The latter are constituted by that set of rules that formally are equal for all and that materially protect private property, the value of money, competition understood as freedom of entry to markets, among other values ​​of modern capitalism.

The distinction between extractive and inclusive institutions can find its parallelism in the expressions of “Rule by Law” and “Rule of Law.” The first consists on the accommodation of general and abstract normative statements with a second intention: to benefit a group at the expense of society as a whole. It is common to hear the criticism that the law has a false neutrality and that therefore any defense of the “Rule of Law” must be ideological (in the Marxist sense of the term). However, what distinguishes the concept of “Rule of Law” from “Rule by Law” is that, for the first of the terms, the consequences are unlikely to be predicted in terms of their particular and even more individual, while the second has an intentionality, declared or hidden.

To give an example, the procedural due process has such a degree of abstraction that it can hardly be predicted who will benefit from those proceedings. However, a law that prohibits the importation of a product of domestic manufacture clearly aims to redistribute resources from consumers to the local producers (although this type of regulation usually also generates consequences that are very difficult to foresee and often contrary to its original intentional).

Critics of the Rule of Law state that it is not neutral, because it protects exclusively the interests of the proprietors. However, such criticism loses sight of the fact that in the Modernity, any inhabitant, even those who are not citizens, can have access to the right to property, regardless of whether or not they belong to a certain caste, class, or social class. This, unlike the legal and political systems of the so-called Ancien Régime, which limited access to private property in perpetuity and irrevocably to a certain group of people, or even more, to a certain clan or group of families. It does not matter if, in Modernity, a person does not own any particular good, as long as he can count on the expectation of being able to become one at some time. In this sense, private property understood in the modern sense as that right that any inhabitant can enjoy from having stability in their possessions to the point of only being stripped of it by their own consent or by following the procedural due process.

This unlike laws protecting infant industries, professions or trades, or promotion of certain activities that are deemed as socially necessary or valuable, which establish a regime of transfers of resources from one sector of society to another. As the School of Public Choice indicates, such laws encourage “lobbying” and reduce the efficiency in the allocation of resources. In such institutional arrangements, individuals and businesses do not prosper through the discipline of serving the consumer, but through political agreements. Economic agents continue to maximize, but at the expense of regulations that deliberately establish certain winners (the owners of protected activities) and certain losers (consumers and potential producers who are denied access to protected activities). Under these circumstances, the citizenry begins to perceive an arbitrary sense in the norms and have no moral issues with challenging them (any contraband, without commercial purposes, is a clear example of this). Obviously, when non-compliance with standards becomes so extensive, regulations become ineffective. Moreover, as James M. Buchanan put it in his brief essay “A policy in the interests of producers,” the stagnation generated by protectionism means that the winners of such a system – the protected producers – turn out to be less rich than they would be in an open and competitive institutional framework.

Sometimes protectionism seeks its foundation in a mistaken theory of “original accumulation.” (Joseph Schumpeter ruled out the validity of such proposals by pointing out that, although those could have had some basis until the 19th century, the development of capital markets made this theory completely obsolete.)

However, neither Douglass North, nor William Easterly, nor Acemoglu & Robinson, deal with the problem of original accumulation. They prefer to encompass such phenomena within the set of erroneous theories that serve to justify policies arising from political agreements in polarized societies. This means that a certain institutional arrangement, an economic growth policy, a stabilization program, a constitutional reform, foreign policy and so on, in a polarized society is not inspired by abstract and formal principles but in concrete goals that benefit certain sectors of society above others.

The examples of polarized societies, to which Easterly and Acemoglu & Robinson turn, come mostly from African countries since these are mostly created in the process of decolonization and comprise different ethnic groups and languages ​​within themselves, so polarization is much more evident: certain policies benefit a certain ethnic group over another. Easterly specifically cites the case of an African nation in which an ethnic group that represents 10% of the population lives in the region where a certain commodity is produced and whose export generates large revenues and, in the meantime, the government is elected, with some exceptions, by 90% of the remaining population, which imposes export rights on the said commodity, whose collection is destined to industrialization plans that systematically fail.

It is often tempting to explain the failure of such industrialization plans for the corruption evidenced in their execution. In fact, corruption cases are verified, but public policy would also fail even if those involved were incorruptible. Many times bad policies destroy much more wealth than political corruption. Corruption implies a transfer of resources and, therefore, an inefficient allocation of resources, while bad public policies result in the destruction of wealth.

However, examples of polarized societies in African countries can generate confusion around the main message of The Elusive Quest for Growth and Why Nations Fail. The economic performance of nations has nothing to do with geography, culture, or lack of preparation of the ruling elites to draw the plans of government. Easterly holds the main responsibility for the rise and fall of nations in incentives, while Acemoglu & Robinson point to the institutions that establish such incentive schemes. Regarding the opinion of Douglass C. North, although his line of research can lend itself to a “culturalist” interpretation, he himself recognizes the disruptive change of formal institutions as a determining factor of economic performance.

In summary, the three works discussed here have as a common denominator the role of incentives as a determinant of the economic performance of countries, above culture (which North would call “informal institutions”), geography, or the level of education of its elites. However, the case of polarized societies is presented as a critical point of such approaches.

José Luis de Imaz in Los que mandan (The ones who command) had defined politics as the activity consisting of articulating diverse interests according to a coherent plan of government. The definition of Imaz deserves to be put back into use, since it addresses the problem of polarization and also because its double edge allows to tie the loose ends left by the visions that we can group, with greater or lesser precision, under the “neo- institutionalist” (clearly the case of North, although it would be pending to discuss the label for Easterly and Acemoglu & Robinson).

Notwithstanding, that polarization is manifest in tribal or caste societies does not mean that it is not present in other societal forms. In the United States, the north and south; in Europe, the separatist movements; in Argentina, the interior and Buenos Aires. With greater or lesser intensity, manifestly or latently, politics is always structured on a space of tension of interests in competition for resources. Those who frequent the work of Carl Schmitt often claim that trade and law are “civilized” means for the exchange and dispute of such resources, politics and war are on the other side of the same question in terms of intensity of the conflict.

However, the term institutions – which define incentives – does not refer only to deliberate political agreements in pursuit of a specific purpose, such as a given public policy. The concept of institution also concerns a series of abstract and general principles whose final result at a particular level no one can foresee, because their level of abstraction imposes an insurmountable limit for the knowledge of its concrete consequences.

[Editor’s note: Here is Part 3; Here is the entire, Longform Essay]

Three Lessons on Institutions and Incentives (Part 3): Innovation means creative destruction

The concept of creative destruction was popularised by Joseph Schumpeter and assumes that the economy is in a equilibrium. The “entrepreneur,” therefore, is an unbalancing factor that, through innovation, displaces the winners of the prevailing situation until then, generating a new equilibrium. This notion was criticized by other economists such as Friedrich Hayek and Israel Kirzner, who saw that the entrepreneur, far from being a disequilibrating factor, obtained its benefits by identifying the points of disequilibrium of a system and arbitrating between them.

The concept of “creative destruction,” on the other hand, focuses on businesses that go to waste from the irruption of the entrepreneur. This emphasis allows us to understand why there will be those who see with fear or disgust the very idea of ​​innovation. In contrast, Hayek and Kirzner emphasize the benefits of the new equilibrium: greater efficiency in the allocation of resources and, consequently, a greater generation of wealth. The notion of Schumpeter allows us to explain why many oppose innovation, that of Hayek and Kirzner gives us reasons to move forward with it. Strictly speaking, in order for innovation not to cause damage at the aggregate level, it must satisfy the Kaldor-Hicks criterion, that is, the gains from innovation must be so high as to allow a hypothetical compensation to the ones who lost the new distribution of resources.

In short, the notion of creative destruction that both William Easterly and Acemoglu & Robinson use, although it might differs from Schumpeter’s, meets the said Kaldor-Hicks criterion. In these cases, innovation does not represent a social disvalue, but on the contrary it generates a benefit for the whole. Therefore, it goes without saying that any brake on an innovation of this nature generates social loss. At this point, if innovation -also called “creative destruction”- is systematically curtailed, in order to seek to protect activities that would otherwise be displaced, society may encounter the following scenarios: a relative delay (regarding its potential) of its development, or a stagnation, or setback. In all three scenarios, inequality in wealth and income increases, or society sees its standard of living delayed or diminished in a homogenous way. In this last case, the protected sectors are also harmed by the brakes imposed on innovation.

[Editor’s note: Here is Part 2; Here is the entire Longform Essay.]

Three Lessons on Institutions and Incentives (Part 2); Institutions: definition and subtypes

Implicitly, Douglass C. North, William Easterly, and Daron Acemoglu & James A. Robinson share the same notion of “institution.” In this respect, what must be taken into account is not a real definition of the former but its operative concept, that is, what characteristic features relate it to the rest of the concepts of each theoretical body. In this sense, we can affirm that for these authors an institution is a limiting factor for human interaction. More precisely, in terms of D.C. North, institutions can be defined as abstract constraints imposed on human social decisions that structure political, economic, and social interaction. The rational agent finds limited its action and its spectrum of choices by institutions, which can be derived as much from the law as from custom, his habits, or his moral constraints.

However, the particular limitations that a particular person experiences are not relevant, but those that are incorporated into the behavior of a large number of human beings that interact with each other, which allows them to recognize a structural pattern of human social action. In this way, although an institution limits human action, because it is widespread throughout the social fabric, building it, it allows each individual inserted in such a set of interactions to represent expectations about the behavior of their fellow human beings that have a high probability of being true (something similar to what Friedrich A. Hayek had previously enunciated in his concept of “spontaneous order”). These expectations allow each individual to make plans with a high degree of probability of accomplishment, or at least to identify those actions that could be ruinous. In this sense, an institution is not only a limitation of human action, but, correlatively, a motivator for it, i. e. an incentive. The structure of human interactions that institutions project in the political, economic, and social fields helps the rational agent to make more efficient decisions, since they have a lower margin of risk. Of course, not all the incentives generate the same economic performance.

It is true that any pattern of human interactions that constrains the scope of choices of the agent (i.e., institutions), however inefficient they might be, represent an advantage over the total absence of it, since it works as a hedge against the arbitrary power and violence from third parties. Thus, the main distinction to be drawn is between anomie and institutionalization.

This latter opinion is expressly stated in Why Nations Fail: the extractive institutions -the ones that establish rules that favor a group at the expense of the whole-, both politically and economically, although they are harmful, are less so than civil war, polarization, factions, or anarchy. Acemoglu & Robinson argue that a country that does not have “inclusive” institutions, but at least have extractive institutions, might experience a rapid development obtained from the importation of discoveries from better organized countries – the phenomenon of “catch up.” However, after reaching a certain maturity, if the country in question does not advance towards political and economic opening, stagnation and subsequent implosion will be difficult to avoid.

Here is where the book of Acemoglu & Robinson finds its point of greatest affinity with the work of William Easterly: to continue on a path of growth and development, countries and their ruling classes must be willing to admit that progress only comes through innovation and that all innovation is accompanied by a process of “creative destruction.”

[Editor’s note: You can find Part 1 here. You can find the entire Longform Essay here.]

Three Lessons on Institutions and Incentives (Part 1): Introduction

There are books that are aimed at a spectrum of readers that are counted within the “well-informed public.” They are not books confined to academic circles, they are not for mass consumption, but they do concern problems that involve entire countries and are written in a register that involves certain intellectual training. In this genre, there are three works that have much to say about the relationship between institutions and incentives. The first of them dates from 1990 and was published by a Nobel Prize winner in Economics, Douglass C. North: Institutions, Institutional Change and Economic Performance, which elaborates the distinction between formal and informal institutions and incremental and disruptive institutional change, ending with a historical analysis that seeks to explain the differences in economic performance between the United States and Latin America. It is an academic book that can be approached by the said well-informed public.

Eleven years later, in 2001, William Easterly published The Elusive Quest for Growth: Economists’ Adventures and Misadventures in the Tropics. It is proposed as a political essay in which an economist interprets his own professional experience as a member of international teams for the development of Third World countries. To do this, drawing on the theoretical notions of other leading economists, such as Paul Romer (who later, in 2018, received the Nobel Prize in Economics), he makes an assessment on the development plans for the Third World that were implemented since the end of World War II. The central thesis of Easterly stresses that, in order to have an empirical relevance, every theory of development -or of the absence of it- must carry the following behavioral postulate: “people respond to incentives.” If this reality is not taken into account, there is no public policy that can be successful. The main lessons that can be drawn come from the theoretical instruments deployed to explain the political dynamics of most of these countries, particularly in regard to the phenomenon of polarized societies.

The third book to consider is also the more recent publication. Why Nations Fail, by Daron Acemoglu & James A. Robinson, was published in 2012 and reached the global debate on the realm of the well-informed public. The proportions achieved by the population of academics and professionals, in addition to the extension of the internet, allowed the aforementioned book to generate varied opinions along both traditional and digital media throughout the world. Acemoglu & Robinson dedicate their pages to those countries that were successful, as well as those that were not, but also here, in the case of this book, the most juicy lessons truly comes from the conceptual structure that articulates the whole book. Among such notions, we find those of inclusive and extractive institutions, which in turn are divided into political and economic institutions. The worst of the institutions are preferable to the total lack of institutions. Thus, a country organized around a closed political and economic system will be preferable to a failed state. However, once a certain degree of centralization and institutionality has been achieved, it is preferable to move towards a pluralist democracy and a competitive economy. The challenge is how to accomplish such transitions.

Since there are still four years left until the year 2023 – following the periodicity of the selected works – we are still in time to make a brief synthesis of the ideas that can be applied to the analysis of the impact of the institutions on economic and political incentives.

[Editor’s note: this is the first part of a rich series on institutions and incentives. You can find the full, Longform Essay here.]

No Country for Creative Destruction

Imagine a country whose inhabitants reject every unpleasant byproduct of innovation and competition.

This country would be Frédéric Bastiat’s worst nightmare: in order to avoid the slightest maladies expected to emerge from creative destruction, all their advantages would remain unseen forever.

Nevertheless, that impossibility to acknowledge the unintended favourable consequences of competition is not conditioned by any type of censure, but by a sort of self-imposed moral blindness: the metaphysical belief that “being” is good and “becoming” is bad. A whole people inspired by W. B. Yeats, they want to be gathered into the artifice of eternity.

In this imaginary country, which would deserve a place in “The Universal History of Infamy” by J.L. Borges, people cultivate a curious strain of meritocracy, an Orwellian one: they praise stagnation for its stability and derogate growth because of the stubborn and incorruptible conviction that life in society is a zero-sum game.

Since growth is an unintended consequence of creative destruction, they reason additionally, then there must be no moral merit to be recognised in such dumb luck. On the other hand, stagnation is the unequivocal signal of the good deeds to the unlucky, who otherwise could suffer the obvious lost coming from every innovation.

In this fantastic country, Friedrich Nietzsche and his successors are well read: everybody knows that, in the Eternal Return, the whole chance is played at each throw of the dice. So, they conclude, “if John Rawls asked us to choose between growth or stagnation, we would shout at him: Stagnation!!!”

But the majority of the inhabitants of “Stagnantland” are not the only to blame for their devotion to quietness. The few and exceptional proponents of creative destruction who live in Stagnantland are mostly keen on the second term of the concept. That is why some love to say, from time to time, “we all are stagnationist” – the few contrarians are just Kalki’s devotees.

These imaginary people love to spend their vacations abroad, particularly in a legendary island named “Revolution”. Paradoxically, in Revolution Island the Revolutionary government found a way to avoid any kind of counter-revolutionary innovation. It is not necessary to mention that Revolution Island is, by far, Stagnantlanders’ favourite holiday destination.

They show their photos from their last vacation in Revolution Island and proudly stress: “Look: they left the buildings as they were back in 1950!!! Awesome!!!” If you dare to point out that the picture resembles a city in war, that the 1950 buildings lack of any maintenance or refurbishment, they will not get irritated. They will simply smile at you and reply smugly: “but they are happy!”

Actually, for Stagnantlanders, as for many others, ignorance is bliss, but their governments do not need to resort to such rudimentary devices as censure and spying to prevent people from being informed about the innovations and discoveries occurring in other countries, as Revolutionary Island rulers sadly do. Stagnantlanders simply reject any innovation as an article of faith!

Notwithstanding, they allow to themselves some guilty pleasures: they love to use smartphones brought by ant-smuggling and to watch contemporary foreign films which, despite being realistic, show a dystopian future to them.

As everything is deteriorated, progress is always a going back to an ancient and glorious time. In Stagnantland, things are not created, but restored. As with Parmenides, they do not believe in movement, but if there has to be an arrow of time, you had better point it to the past.

Moreover, Stagnantland is an imaginary country because it does not only lack of duration, but of territory as well. As the matter of fact, no man inhabits Stagnantland, but it is indeed stagnation that inhabits the hearts of Stagnantlanders. That is how, from dusk to dawn, any territory could be fully conquered by the said sympathy for the stagnation.

Nevertheless, if we scrutinise the question with due diligence, we will discover that the stagnation is not an ineluctable future, but our common past. Human beings appeared very much earlier than civilisation. So, all those generations must have been doing something before agriculture, commerce, and institutions.

Before the concept of creative destruction had been formulated by Joseph Schumpeter, it was needed a former conception about how people are conditioned by institutions: Bernard Mandeville pointed out how private vices might turn into public benefits, if politicians arranged the correct set of incentives. The main issue, thus, should be the process of discovery of such institutions.

That is why the said aversion to competition and innovation is hardly a problem of a misguided sense of justice, but mostly a matter of what we could coin as “bounded imagination”: the difficultly of reason to deal with complex phenomena. Don’t you think so, Horatio?

The Negative Capability of a Good Legislator

In a former post, we had explored the idea of considering the law as an abstract machine which provides its users with information about the correct expectancies about human conduct that, if fulfilled, would contribute to the social system inner stability (here). The specific characteristic of the law working as an abstract machine resides in its capability of dealing with an amount of information more complex than human minds. This thesis had been previously stated by Friedrich Hayek in his late work titled “Law, Legislation and Liberty”, aimed to provide the foundations to a proposal of an constitutional reform that would assure the separation of the law from politics -not in the sense of depriving politics from the rule of law, but to protect law from the interference of politics.

Paradoxically, the said opus had many unintended outcomes that surpassed the author’s foresight. One of them was the coinage of the notion of “Spontaneous Order”, which Hayek himself regretted about, because of the misleading sense of the word “spontaneous”. At the foreword of the third volume of the cited “Law, Legislation and Liberty”, he explained why he would prefer to use of the term of “Abstract Order”. Notwithstanding its creator’s allegations, the label of “Spontaneous Order” gained autonomy from him in the realm of the ideas (for example, here).

Why better “abstract order” than “spontaneous”? Because while no “concrete order” might be spontaneous, we could nevertheless find normative systems created by human decision, besides the spontaneous ones (see “Law, Legislation and Liberty”, Chapter V). Moreover, we do not see spontaneous orders whose rules fail to provide stability to the system, because of “evolutionary matters”: such orders could not endure the test of time. Nevertheless, for the same reason, we could imagine a spontaneous order whose rules of conduct became obsolete due to a change in the environment and, thus, fails to enable the social system with the needed stability.

Spontaneity is, thus, not the central characteristic of the law as a complex order. What delimits law from a “concrete order” is the level of abstraction. An alternative name given by Hayek to designate the concrete orders was the Greek term “taxis”, a disposition of soldiers for battle commanded by the single voice of the general. Concrete orders could be fully understood by the human mind and that is why they are regarded as “simple phenomena”: the whole outcome of their rules could be predicted by a system of equations simpler than the human mind.

Notwithstanding a single legislator could sanction a complete set of rules to be followed by the members of a given society, the inner system of decision making of those individuals are more abstract that the said set of rules and, thus, the human interactions will always result in some subset of unintended consequences.

These unintended consequences should not necessarily be regarded as deviations from the social order, but indeed as factors of stabilisation -and, thus, all abstract orders are, in some sense, still spontaneous. These characteristics of the law as a complex order concern on the information about the final configuration of a society given a certain institutional frame: we can establish the whole set of institutions but never fully predict its final outcome. At this stage, we reach what Hayek called in The Sensory Order “an absolute limit to knowledge”.

We now see that the legislator could sanction a complete system of rules -a system that provides solutions for every possible concrete controversy between at least two contenders-, but he is unable to be aware of the full set of consequences of that set of rules. We might ascertain, then, that being enabled with a “negative capability” to anticipate the outcome of the law as a complex phenomenon is a quality to be demanded to a good legislator.

By this “negative capability” we want to designate some understanding of the human nature that allows to anticipate the impact of a given norm among the human interactions. For example, simple statements about human nature such as “people respond to incentives”, or “all powers tend to be abusive”. These notions that are not theoretical but incompletely explained assumptions about human nature are well known in the arts and literature and constitute the undertow of the main narratives that remain mostly inarticulate.

Precisely, as Hayek stated, every abstract order rests upon a series of inarticulate rules, some of which might be discovered and  later articulated by the judges, while other rules would remain inarticulate despite being elements of the normative system.

However, we praise Negative Capability as a virtue to be cultivated by the legislator, not by the judge. The function of the judge is to decide about the actual content of the law when applied to a particular case. It is the legislator the one who should foresee the influence to be exerted by the law upon a general pattern of human behaviour.

Notwithstanding Negative Capability could be dismissed in order of not being a scientific concept, this negative attribute is one of its main virtues: it means lack of ideology, in the sense given to that term by Kenneth Minogue. While an ideological political discourse reassures itself in a notion of scientific truth, at least a legislator inspired by common and humble ideas about human nature would be free from that “pretence of knowledge”.

Rule of Law: the case of open texture of language and complexity

This article by Matt McManus (@MattPolProff) recently published at Quillette made me remember H.L.A. Hart’s theory of law and the problems derived from the open texture of language, a concept borrowed by him from Friedrich Waismann, an Austrian Mathematician and philosopher of the Vienna Circle. Many authors would rather distinguish “open texture” from vagueness: being the latter a proper linguistic matter, the former is related to the dynamic of the experience. As Kyle Wallace summarized the problem: “certain expressions are open textured simply because there is always the possibility that in some new experience we may be uncertain whether or not the new expression is applicable.”

However, Brian Bix, in his “H.L.A. Hart and the ‘open texture’ of language,” argues that, despite the concept of “open texture” being a loan from Waismann’s philosophy, the use gave to the term by Hart is not derogatory at all. With respect to Hart’s point of view, the “open texture” of the law is rather an advantage, since it endows the judges with a discretionary power to adjust the text of the law to the changing experience.

Concerning individual liberty, the laudatory qualification of the open texture of the law made by Hart and Bix might be shared by the jurists of the Common Law tradition, but it hardly would be accepted by anyone from the Civil Law System. According to the former, every discretionary power enabled to the judges helps to prevent the political power from menacing individual liberties, while, following the latter, the written word of the law, passed by a legislative assembly according to constitutional proceedings, is the main guarantee of individual rights.

But the subject of the open texture of the language of the law acquires a new dimension when it is related to the coordination problem derived from the limits to knowledge in society. As it was distinguished by F. A. Hayek in the last chapter of Sensory Order, we could talk about two types of limits to knowledge: the relative and the absolute. The relative limit to knowledge depends upon the sharpness of our instruments used to gather information, whereas the absolute limit to knowledge is sealed by the increasing degrees of abstraction that constitute every classification system. Since every new experience demands the rearrangement of the current system of classification we use to order our perception of reality, the description of this feedback process requires a supplementary system of classification of a higher level of complexity. The progress of the subject of knowledge into higher levels of abstraction reaches an unconquerable limit when he is tasked with the full study of himself.

Thus, we could ascertain that the judiciary function would be enough to fulfill the problems that could arise from the open texture of law, since the judge pronounces the content of the law not in general terms, but in concrete definitions in order to solve a case. In this labour, the judge not only applies the positive law, but he might “discover” abstract principles that become relevant in order to the given new experiences that begot the controversy over the content of the law he is due to solve. This function of “immanent critique” of the positive law by the judiciary system is well discussed by F. A. Hayek in the fifth chapter of his Law, Legislation and Liberty. Since the judiciary function solves in every concrete case the coordination problem derived from the fragmentation of knowledge in society, the open texture of the law does not make it opaque to the citizens.

That notwithstanding, the open texture of the law remains as a systemic limit to the legislative assemblies to define the whole content of the law. Thus, since the whole content of the law can only be achieved in a given concrete case by a judge solving a particular controversy, every central planner would have to accomplish his model of society not through decisions based on principles, but on expediency. Central planning and rule of law will be always set to collide. In this sense, the concept of open texture of the law might work as a powerful argument for the impossibility of every central planning to be performed, sooner or later, under the rule of law.

Red Lobsters and Black Swans

Back In 2007 Nassim Nicholas Taleb had estimated that, in the following years, the rate of irruption of highly improbable events that change our way to perceive reality would be on the increase. Using his terminology, we would swiftly drift from Mediocristan out to Extremistan. People would have to deal with black swans more often and adapt to the new scenario.

The sudden spreading of Jordan Peterson’s lobsters might be a confirmation of Taleb’s surmise (in Extremistan, the term “surmise” has not any derogatory connotation). “Stand up straight with your shoulders back” is a piece of advice aimed at people who feel overwhelmed by a state of affairs, both personal and public, whose complexity they can hardly grasp. In Taleb’s terms, Jordan Peterson wants to prepare you for a world in which the Black Swans are the underlying reality.

Our quantitative patterns about reality -both physical and social- contribute to preserve fixed relationships among the terms that build up our world and subjectivity -while every now and then the “untimely” burst into our sense of reality. The Nietzschean “untimely” had always been there, out of the reach of our horizon of perception, but ready to appear suddenly and unexpectedly, like the plague in Thebes.

Nevertheless, perhaps there is no underlying chaotic reality, but a Hofstadter’s braid, where Apollo and Dionysus are intertwined: simple and complex phenomena, back to back, the beauty and the sublime. Upon one side, the train of events represented by a correlative train of thoughts; on the reverse, a plane of unarticulated notions that are inherent to those representations.

In this sense, the matrix of Taleb’s Black Swans might not inhabit the undertow of our perceptions, but stand above them, in a plane of a higher degree of complexity. Each new event triggers our brain to readjust our system of classifications. But this readjustment, at its time, triggers off a reconfiguration in the said plane of unarticulated notions that give support to our set of representations. In principle, an arrangement of such events would remain stable, but sometimes some unintended consequences could arise. That is the dynamic of events that Friedrich Hayek had once tried to convey with his concept of spontaneous or abstract order.

Peterson’s Red Lobsters try to make us reflect on the edge of our common patterns of conduct, whereas Taleb’s Black Swans incite us to perform the speculative activity of throwing hypothesis over the singularity of the abstract order, so that to anticipate any unintended consequences of our individual or collective behaviour. Notwithstanding the huge differences that there might be between them, what deserves our main attention is the acknowledgement of that the unplanned, the unexpected, the uncertain, are not alien forces, but the inherent articulation of the patterns of events that constitute the matter we are face to deal with.

George Halm against Common Wisdom on Currency Boards

Motivated by the recent decision of Argentina’s government to ask for an stand-by loan to the I.M.F., after a run on the peso, the last The Economist’s Bello section gives an account of the history of the relationship between them and makes a remark about the Argentine currency board experience between 1991-2002 that today is almost common wisdom: Since convertibility meant forgoing exchange-rate flexibility and an independent monetary policy, fiscal discipline was all-important for its success.”

But by the time the I.M.F. was being created, that was not an unanimous opinion. We have the example of George N. Halm who, in his book Economics of Money and Banking, stated that every Currency Board must implement a countercyclical policy on reserve requirements to be held by the commercial banks. Thus, the Currency Board could neutralize or mitigate an expansion or contraction of the base money by alternatively increasing or lowering the reserve requirements of the banks. For George Halm, a Currency Board could be almost in full command of monetary policy -and even more with respect to any other system, since it retains its political independence.

It is hard to imagine a Halm’s Currency Board that promotes a rapid economic growth which, in turn, could bring any popularity to its implementation. But it is as hard to imagine as the probability that a monetary system as such could end up in a bank run.

Deep Learning and Abstract Orders

It is well known that Friedrich Hayek once rejoiced at Noam Chomsky’s evolutionary theory of language, which stated that the faculty of speaking depends upon a biological device which human beings are enabled with. There is no blank slate and our experience of the world relies on structures that come from the experience in itself.

Hayek would be now delighted if he were told about the recent discoveries on the importance of background knowledge in the arms race between human beings and Artificial Intelligence. When decisions are to be taken by trial and error at the inside of a feedback system, humans are still ahead because they apply a framework of abstract patterns to interpret the connections among the different elements of the system. These patterns are acquired from previous experiences in other closed systems and provide with a semantic meaning to the new one. Thus, humans outperform machines, which work as blank slates, since they take information only from the closed system.

The report of the cited study finishes with the common place of asking what would happen if some day machines learn to handle with abstract patterns of a higher degree of complexity and, then, keep up with that human relative advantage.

As we stated in another place, those abstract machines already exist and they are the legal codes and law systems that enable their users with a set of patterns to interpret controversies concerning human behaviour.

What is worth being asked is not whether Artificial Intelligence eventually will surpass human beings, but what group of individuals will overcome the other: the one which uses technology or the one which refuses to do so.

The answer seems quite obvious when the term “technology” is related to concrete machines, but it is not so clear when we apply it to abstract devices. I tried to ponder the latter problem when I outlined an imaginary arms race between policy wonks and lawyers.

Now, we can extend these concepts to whole populations. Which of these nations will prevail over the other ones: the countries whose citizens are enabled with a set of abstract rules to based their decisions on (the rule of law) or the despotic countries, ruled by the whim of men?

The conclusion to be drawn is quite obvious when we are confronted with a so polarised question. Nevertheless, the problem becomes more subtle when the disjunction concerns on rule of law vs deliberate central planning.

The rule of law is the supplementary set of abstract patterns of conduct that gives sense to the events of the social reality in order to interpret human social action, including the political authority.

In the case of central planning, those abstract patterns are replaced by a concrete model of society whose elements are defined by the authority (after all, that is the main function of Thomas Hobbes’ Leviathan).

Superficially considered, the former – the rule of law as an abstract machine – is irrational while the latter – the Leviathan’s central planning – seems to respond to a rational construction of the society. Our approach states that, paradoxically, the more abstract is the order of a society, the more rational are the decisions and plans that the individuals undertake, since they are based on the supplementary and general patterns provided by the law, whereas central planning offers to the individuals a poorer set of concrete information, which limits the scope of the decisions to those to be based on expediency.

That is why we like to state that law is spontaneous. Not because nobody had created it -in fact, someone did – but because law stands by itself the test of time as the result of an evolutionary process in which populations following the rule of law outperform the rival ones.

In the Search for an Optimal Level of Inequality

Recently, the blog ThinkMarkets published a post by Gunther Schnabl about how Friedrich Hayek’s works helped to understand the link between Quantitative Easing and political unrest. The piece of writing summarized with praiseworthy precision three different stages of Friedrich Hayek’s economic and political ideas and, among the many topics it addressed, it was mentioned the increasing level of income and wealth inequality that a policy of low rates of interest might bring about.

It is well-known that Friedrich Hayek owes the Swedish School as much as he does the Austrian School on his ideas about money and capital. In fact, he borrows the distinction between natural and market interest rates from Knut Wicksell. The early writings of F.A. Hayek state that disequilibrium and crisis are caused by a market interest rate that is below the natural interest rate. There is no necessity of a Central Bank to arrive at such a situation: the credit creation of the banking system or a sudden change of the expectancies of the public could set the market interest rate well below the natural interest rate and, thus, lead to what Hayek and Nicholas Kaldor called “the Concertina Effect.”

At this point we must formulate a disclaimer: Friedrich Hayek’s theory of money and capital was so controversial and subject to so many regrets by his early supporters – like said Kaldor, Ronald Coase, or Lionel Robbins – that we can hardly carry on without reaching a previous theoretical settlement over the apportations of his works. Until then, the readings on Hayek’s economics will have mostly a heuristic and inspirational value. They will be an starting point from where to spring new insights, but hardly a single conclusive statement. Hayekian economics is a whole realm to be conquered, but precisely, the most of this quest still remains undone.

For example, if we assume – as it does the said post – that ultra-loose monetary policy enlarges inequality and engenders political instability, then we are bound to find a monetary policy that delivers, or at least does not avoid, an optimal level of inequality. As it is explained in the linked lecture, the definition of such a concept might differ whether it depends on an economic or a political or a moral perspective.

Here is where I think the works of F.A. Hayek have still so much to give to our inquiries: the matter is not where to place an optimal level of inequality, but to discover the conditions under which a certain level of inequality appears to us as legitimate, or at least tolerable. This is not a subject about quantities, but about qualities. Our mission is to discover the mechanism by which the notions of fairness, justice, or even order are formed in our beliefs.

Perhaps that is the deep meaning of the order or equilibrium that it is reach when, to use the terminology of Wicksell and Hayek’s early writings, both natural and market interest rates are the same: a state of affairs in which the most of the expectancies of the agents could prove correct. The solution does not depend upon a particular public policy, but on providing an abstract institutional structure in which each individual decision could profit the most from the spontaneous order of human interaction.

Law and Liberty: Hobbesians vs Rechtsstaaters

Individual freedoms are tethered to law, but in what sense? We could call Hobbesian the insight into law and liberty which states that norms are addressed by the sovereign power to the individuals. The Sovereign is the only one who prescribes the law, being the individuals subject to the legal obligation. Even the limitations to the power of the government in the face of fundamental rights – such as the Due Process – are not expressed in terms of limits to the sovereign power but of commands to the public servants: for example, the imprisonment of an individual without accomplishing the legal standards of Due Process allows the government’s agents to punish their unlawful colleagues. The law is always addressed, in the last resort, to an individual by the State.

Proponents of individual liberty thus advocate equality before the law, which means simply “only one state for everyone,” or “individual rights before the state.” Examples include the said guarantee of Due Process, or a system of check and balances among the branches of the government as safeguards against arbitrary coercion by the State. However, they all have a severe difficulty in defending individual liberties without recourse to an extra-system concept, such as natural law, moral duties, or political statements. The emphasis in formal legal procedures would be the utmost in coherence between liberalism and Hobbesianism, but it is easy to slide from procedures that protect individual legal rights to devices assuring the enforcement of the law – which has the individual as its last subject. It seems it is hard to restrain oneself from invoking metaphysical rights when it comes time to advocate individual liberty.

Nevertheless, it should not be surprising that every limit to political power of the State over the individual depends on metaphysical notions, since it is a tenet of the Hobbesian insight that the power of the State is absolute. Moreover, the Minimal State – a true effort to advocate individual liberty without resting on metaphysical notions – owes to Thomas Hobbes its main inspiration.

Historical evidence suggests, however, that in the relation among power, law and liberty is the other way round. The development of common law in England and the phenomenon of the reception of the Roman law in Continental Europe show that law is not necessarily created ex nihilo by the State. The State could provide enforcement to a given system of law, as it is shown in the book System of the Modern Roman Law (System des heutigen Römischen Rechts), by F. K. v. Savigny. Moreover, the States could adapt legal notions originating in private law to elaborate procedures to follow in the public sphere. The principle “venire contra factum proprium non valet” was born in private law and today is a guarantee to the individual against the arbitrary action of the State.

This is the process of rationalization of power described by Max Weber, the German concept of Rechtsstaat or the widely known concept of “Rule of Law.” In that process of rationalization, lawyers outshone the sages, the mandarins, and the humanists in the administration of public affairs by incorporating legal procedures and principles taken from private law. There might be differences among these concepts and historical events, but their common invariances allows us to get the gist.

There is, also, an evolutionary case for the relative advantages of a Rechtsstaat over the notion of sovereignty. In the former the decisions are principle-based while in the latter they are mostly taken by expediency. Since the said principle of venire contra factum proprium non valet and other legal procedures constrain rulers’ whims, government actions are more rational, in the sense of transitivity of preferences.

Thus, in the long run, the performance of the Rule of Law is higher than the Rule of Men. Lawyers outshine mandarins in government posts and, in turn, governments run by lawyers outperform governments run by mandarins. One device to switch from a given form of State to another one is, for example, immigration: people flock to countries where the Rule of Law prevails.

What we have called the Hobbesian insight into Law and Liberty is tied up with the definition of liberty as power. Thus, the equation of law and liberty becomes a zero-sum game: the more state, the less individual liberty, and the less state, the more individual liberty. On the other hand, the definition of individual liberty as absence of arbitrary coercion engages with the concept of Rule of Law: to substitute principles for expediency reduces arbitrary coercion and, thus, enlarges individual liberty.

Does this Rechtsstaat insight into Law and Liberty dissolve the question about the dimensions of the State? Not at all. But it provides a more strategic view: a big State will demand more decisions to be taken on expediency. A small state will provide two advantages to the enjoyment of individual liberty as absence of arbitrary coercion: more decisions based on principles and a larger space for the law to evolve by its own and discover new legal principles in response to the constant changes in the society.

But even if the conclusions might be the same (a smaller State), the two insights carry within them a set of premises that ineluctably will unravel by themselves when it comes the time of a deeper controversy. Then, the Hobbesian Insight will present the disjunction between Minimal State and metaphysical boundaries to the absolute power of the State. The Rechtsstaat strain, instead, will provide a humbler but subtler position.