Institutions, Machines, and Complex Orders (Part 6): Institutions as algorithms

There is therefore a category of phenomena to which the characteristic of being “simple” is attributed (in contrast to the so-called complex), ordered by logical models whose capacity for explanation and prediction is continuously tested by means of a system of trial and error that allows readjusting these models in a process of continuous approach to the truth. The progress in the knowledge of these simple phenomena also depends on the measurement tools that are available: statistical methods, more powerful microscopes, laboratory experiments, etc.. The investigation of simple phenomena consists of a process in which it goes to a greater degree of specificity and concretion. It is for this reason that it is difficult to distinguish whether their theories consist of logical models or empirical models, since they mostly consist of the description of relations and functions between given events.

In the opposite sense of intellectual inquiry, complex phenomena are located: their study consists in the statement of the relationships and functions that structure an abstract order of events. An everyday example of such abstract orders of events can be found in the phenomenon of written laws, both procedural and substantive. In them you can find credit relationships, procedural burdens, temporary periods to exercise actions or rights under penalty of estoppel, or prescription or expiration, assigned functions to produce legal norms of general or particular scope, etc.. The application of such abstract models to the concrete reality is known as “jurisdiction,” that is to say “to say the right for the concrete case.” Of course, for this depend elements of proof and a critical judgment that interprets the given events assigning the legal qualification and the legal consequences of that that the law prescribes in abstract and general form. The jurisdictional activity could be characterized as a “simple phenomenon,” however, the same would not happen with the “science of legislation.”

In effect, when what is studied is a legislative reform, what is being done is to increase in degrees of complexity in the study of standards. The legislator is no longer exclusively discussing legal issues. It could do it: study for example the coherence of a new norm whose sanction is under study with the rest of the juridical order, nevertheless still it is extremely difficult to foresee the set of consequences of a reform on the global operation of the juridical order. However, if this is already difficult in itself, it becomes much more complex when philosophical and political issues come into play in the legislative debate. In the legislative debate on the sanction of the norms, a point arrives at which the legal analysis ceases, in the sense that the discussion takes the fervour of the political philosophy or the cold calculation of the negotiation to reach a legislative majority.

[Editor’s note: You can find Part 5 here, and you can read the full essay here.]

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.]

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”.

The Politics of the Incredibles (minimal spoilers)

I saw an early release of the Incredibles 2 last night. I wasn’t expecting too much given Pixar’s history with sequel. Finding Dorothy, Monsters University and the Cars sequels were okay, but below average for Pixar. I am happy to report that the Incredibles 2 was a pleasant exception. Not only did the film re-capture the magic of the original, it made a point that many readers and fellow Notewriters should appreciate: legality doesn’t equal right.

The film starts off directly after the events of the first film. The titular Incredibles family fights off the Underminer, a mining themed super villain. Instead of getting praised for their actions though, they get arrested. Superheroes are still illegal. The events of the past film haven’t changed that. One of the characters wisely remarks, “Politicians don’t understand why someone would do the right thing for its own sake. They’re scared of the idea.”

The family is let go, but they’re at a low point. Their home has been destroyed. They’re unemployed and broke. They’re gifted with super powers, but they live in a world where they can’t legally use them. That’s when a businessman approaches them and asks – why not use their super powers? The businessman proposes that the family continue to use their powers illegally, and convince the government to change the law after the public has been shown how useful superheroes are. This leads to a funny exchange where the characters argue about how they’re being asked to be illegal in order to become legal.

I won’t spoil the remainder of the film, but I love the businessman character’s early scenes. It’s refreshing to see a corporate character, and his disregard for legislated morality, portrayed in a positive light. Tony Stark/Iron Man starts off this way in the early MCU films, but makes a u-turn by Captain America: Civil War. This new character, for better or worse, stands by his beliefs.

The tension between legislation and morality isn’t a new theme for Pixar. The idea of breaking the rules to do what’s right was a central feature of Monsters University as well. It’s a lesson I think many children, and their parents, could benefit to learn. Legislation isn’t morality.

I give the film a solid 9/10. It’s around Wall-E or Up levels of quality. It’s easily one of the funniest Pixar films in a while. The animated short before the film is, as standard for Pixar, a tear jerker. Bring some tissues.

Thoughts? Opinions? Post in the comments.

Hume and Humboldt

Divergent dichotomies are not unusual to be found in Hayek’s writings. Besides the essay “Two Types of Mind”, we have his 1945 lecture “Individualism: True and False” on the difference between the British Enlightenment and the Continental Rationalism. Grounded in Edmund Burke’s Appeal from the New to the Old Whigs, Hayek traces the origin of true individualism to Bernard Mandeville, David Hume, Josiah Tucker, Adam Ferguson, Adam Smith and Edmund Burke himself. The XIX Century adds Lord Acton and Alexis de Tocqueville to the list. On the other hand, Hayek states that Jean Jacques Rousseau exemplifies the Rationalist individualism, which postulates isolated and self-contained individuals –whereas, for the former, the individual is determined by his existence in society. The “true variant” of individualism is the notion of “subject” of Hume’s philosophy: the outcome of repetitions, expectancies and habits. Finally, Hayek concludes his lecture with the censure to the German type of individualism, rooted in Wolfgang v. Goethe and Wilhelm v. Humboldt: the individualism expressed in the original development of the personality and defended in J. S. Mill’s On Liberty.

Notwithstanding in this 1945 lecture Hayek claims that this German individualism of self-development has nothing to do with what he regards as true individualism and it is “an obstacle to the smooth working of an individualistic system,” much later, in Law, Legislation, and Liberty, he will restate his opinion on Wilhelm v. Humboldt’s legacy.

This reconsideration of the value of liberty as the development of the unique and particular character of an individual will be acknowledge not only regarding legal theory but as well in his 1976 proposal of denationalization of currency. In his late writings, Hayek will endorse the development of the originality of character as an important trait for the competition to work as a discovery process.

The key to understand his shift onto this new type of individualism is closely related to Hayek’s involvement into the ideas of cultural evolution. The “true individualism” was important to state how a society can achieve certain order. The “Humboldt’s individualism” is needed to explain the dynamic of the evolution of that order. Hume’s notion of subject is related to the ideas of integration and convergence, to how an order may emerge. Humboldt’s ideal of self-development of the unique and original character of each individual implies differentiation and divergence. These two traits are the key to the adaptation to the changes in the environment that defines the notion of blind evolution. A social and political system that assures the development of differences has keen aptitudes to survive to the changes in its environment. At the level of the “true individualism”, individuals are made of institutions, repetitions and expectancies. But at the level “Humboldt´s individualism”, successful institutions are made of differences, divergent series of facts and adaptation.

(Originally published in http://www.fgmsosavalle.blogspot.com)

Ron Paul, Change Agent

From what I can tell, a “change agent” in the lingo of the conspiracy theorist is a person who seems alright on the surface but in reality is bought and paid for by the New World Order/Illuminati/Bilderbergs and whose primary function it to co-opt the opposition and channel their frustration into fruitless endeavors, so that the powers that be may effect the change they desire with virtually no threats to their plan. If someone like Ron Paul can be accused of this, of course, then no one is safe. Which is why using the term “change agent” in this way has little effect. But as an actual agent of change, Ron Paul’s record speaks for itself, I think. No, I don’t mean his legislative record, for this is rarely something anyone should be proud of, and at best serves only to condemn the person in question for the misdeeds they have committed in the name of making law and doing the will of the people. I refer to his other record. His list of achievements in public life outside of the halls of Congress.

The man has single-handedly convinced thousands upon thousands of people to adopt a more freedom-oriented outlook on life, if not also to utterly transform their worldview. And he continues to do so with his latest book, which I received in the mail today not more than a few hours ago. I’m already reading it and in the first chapter he is keen to stress the ideas that liberty and personal responsibility go hand in hand (one might term this a “Virtuous Voluntaryism“) and that an education’s structure and content must be consistent with one another in order to be effective.

I hope that thousands if not millions of people read this book (and/or others like it) and come away from it with a fresh or reinforced opinion on what needs to be done with our education system (hint, the bulk of the fight takes place outside of “the system”), which is in a complete shambles. Because that’s just how many people it is going to take to reform fix restructure completely uproot the current establishment. Doing this is an end in itself, of course. But it is also a means to a far greater goal. Children raised by the state cannot help, on the whole, but to be children raised for the state. Ron Paul forcefully drives home the point that the status quo cannot be successfully challenged without first addressing the wholesale brainwashing of what many deem to be society’s greatest asset: the children. Stop the elites and bureaucrats on this front and victory over them in perhaps every other field of battle is all but assured.

So I encourage you to read this book, to suggest to others that they read it, and once done, to share (your/their) copy with still others (could be wrong, but I think it’s WAY easier to do this with a hard copy than with a Kindle or iPad). That is what I intend to do with mine. I hope and expect to be finished with it within the week.

Bank Deregulation: Friend or Foe?

Banking has changed a lot during my lifetime—for the better. The changes are partly due to technology (ATMs, online access), but also to deregulation that subjected banks to a lot more competition. What were the major deregulatory moves and how might they have contributed to the recent crisis? Before addressing those questions, a little personal history.

I got interested in money and banking at a very young age. My mother often took me along on shopping trips, explaining what money was, why we needed it in stores, and how my father got it for us. Trips to the bank were a special treat. The Cleveland Trust branch near us was an imposing affair, with a limestone façade, high ceilings, and tellers ensconced behind ornate barred windows. The architecture was intended to instill confidence, but to me it was just a magic place.

Later, my sixth-grade class operated a student branch of another bank, the Society for Savings. Twice a month our classroom was rearranged like a bank branch. Tellers (all boys, as I recall) would accept student deposits of a dime, a quarter, or sometimes a whole dollar. Assistant tellers (girls) would write the amount of the deposit in the student’s passbook, while the boys handled the cash. After closing we tallied the deposits and packed the loot—perhaps $50—into a canvas bag, and a privileged student would trundle it off to the principal’s office under the watchful eyes of two “guards.” What great lessons we learned: thrift, honesty, attention to detail!

By the time I was 14 I was earning good money shoveling snow, raking leaves, and mowing lawns. I had become something of a saving fanatic. I soon found out that the local savings and loan (S&L) offered higher interest than commercial banks, so I opened an account there. Savings passbooks seem quaint in hindsight, but mine was a treasured possession, a tangible reminder of my growing nest egg. Continue reading