[The Institutional Revolution♦ by Douglas Allen ♦ University of Chicago Press, 2012]

Coordination of decentralized human activity requires, amongst other things, institutions. Nature and the limitless scope of human choice can make organizing production and exchange difficult. People, for instance, are often difficult to trust and uncontrolled nature can restrict the precision of human action. To help mitigate these problems, societies developed institutions. These are the structures of rules — whether formal or informal — that guide and constrain decision making. But, institutions vary widely from society to society and, within societies, from era to era. Why? What determines which institutions are relevant and efficient? Douglas Allen, in The Institutional Revolution, helps us approach an answer to this question by looking at some of the institutions of pre-modern England.

Modern institutions began to develop in the late 19th century, and one important facet behind their emergence was the human “conquest of the physical environment.”[1] Growth in scientific knowledge allowed for its application, including innovative new technologies which improved our capacity to reduce much of the variance inherit in nature. We, for example, take for granted that we have an accurate measurement of time, through our wristwatches, cell phones, kitchen appliances, and just about everywhere else. Two hundred years ago, even pocket watches were hard to come by, especially for the non-wealthy, and the technology was not necessarily very precise. It was only after the 1850s that standardized, precise watches began to be mass produced. Imagine the difficulty that the pre-moderns had in establishing exact meeting times or designing shifts. Problems like these conditioned the institutions of that era.

Pre-modern English institutions looked very different to our own today. In fact, from a modern perspective, many of those institutions seem corrupt and inefficient. But, our judgment takes for granted just how much control we exert over nature. We do not face the same problems, or constraints, that pre-moderns did. Their rules, their customs, and their way of doing things have to be interpreted within their proper context. This is what Douglas Allen does in his book. He looks at the English aristocracy, including the custom of dueling, the Royal Navy, the British Army, the private provision of security, roads, and lighthouses, and the organization of the Crown’s tax collectors. He interprets the rules of these systems within their proper context, seeing order where others see corruption, profiteering, and wastefulness.

English governance, between ~1600–1850, provides an interesting example of the peculiarities of the institutions of that era. Before the advent of modern, (ideally) merit-based bureaucracy, governments had to think of alternative ways of mitigating shirking. Wage-based systems make sense when hourly output can be cost-effectively monitored. The pre-moderns, for the most part, did not have this luxury, so they relied on a different system, based on patronage, lavage, but largely illiquid investment, and seemingly benefit-less methods of proving one’s honor, such as dueling. On the surface, such a system does not seem too promising, but, given the constraints of the time, these bureaucratic institutions were actually relatively efficient.

At the time, only the aristocracy had access to the English bureaucracy. This was the era of lavish countryside estates, with sprawling gardens, and large social gatherings. It is easy to doubt the social utility of these types of investments, especially when compared to the various entrepreneurial investments that the aristocracy could have made instead, but Allen argues that they had a purpose within the institutional framework of pre-modern English governance. Without the ability to monitor effort directly, the Crown opted for a profit-and-loss alternative. But, profit-and-loss only works as a disciplining process if people stand to lose. English countryside houses represented that potential loss. Before being accepted into the aristocracy, the wealthy had to invest much of their wealth in things like countryside estates. Outside of the nobility, these homes had little value: they were illiquid assets. Thus, if an aristocrat was caught shirking, he could be effectively banned from the nobility and left with a largely valueless asset — and, of course, without the significant stream of income that came with holding a public position.

Beyond initial investments in illiquid capital, the Crown relied on signaling of trust as a means of gauging the merit of individual aristocrats. Wealthy businessmen could not just buy large estates and call themselves members of the nobility. It was an inner circle, with some opportunity for entry, where the members knew each other, including whether or not they had breached the trust of the Crown. Outside investment was discouraged and looked down upon, and gaining social recognition was a multi-generational project, implying that the decision to invest in the aristocracy had the implication of a large opportunity cost. But, over time, if one could break into the aristocratic circle, there was much wealth to be earned by working for the government.

If a family’s wealth was relatively limited, there were alternative means of gaining social recognition and trust. One of these methods was dueling. It also served as a screen, to weed out those who did not have the social capital to be an aristocrat. Dueling carries some risk of death, and it only makes sense to commit oneself to a duel if there is something to gain. At the same time, however, the gains may provide an incentive for cheating and for non-aristocrats to partake as a means of faking social capital. Therefore, legal restrictions were placed on whom can duel and the rules of dueling minimized the opportunity for activities that created an inequality of advantage between the two people involved. For the most part, as a result of both formal restrictions and an informal structure of incentives, dueling was restricted to the lower gentry — the less well-off nobility —, and the outcome was generally as random as possible. The weapons used were typically not very effective, minimizing the importance of training, and there were official judges present, called seconds, to look over the event. Who lost or won usually did not matter; the very act of dueling was a partial proof of one’s social capital. Not dueling, on the other hand, was proof of a lack of social capital.

With technological changes and the introduction of methods of direct monitoring, the relevance of aristocrats as bureaucrats faded. In, what was by that time, Great Britain, this institutional framework was gradually replaced with a wage- and merit-based bureaucracy, where most members of society had the opportunity for entry. The transition was not only peaceful, but it was largely voluntary, with the landed gentry opting for more financially rewarding opportunities elsewhere.

The other institutions that Douglas Allen explores are equally as interesting, and often just as surprising. The Royal Navy, for example, was structured not necessarily to take advantage of the best military tactics, but to help guarantee that a ship always had an incentive to act in the Crown’s interest. This differed markedly from the institutions of the French navy, which placed a lot of emphasis on tactical finesse and battlefield freedom. Yet, it was the Royal Navy which eventually ruled the waves.

Allen’s theoretical narrative, however, leads us to the question of whether institutions can be efficient. Why did the institutional structure vary between countries? Why was English government so well organized, but still differed in various important respects from their continental counterparts? Why did the French navy not adopt English institutional restrictions? Allen does not offer a very convincing answer. There are, however, some hints towards an explanation, including the idea that institutions are more likely to be efficient — within given constraints (e.g. technology) — if they arise in a competitive environment. One can pair these ideas with those of economists like Daron Acemoglu, who specialize in seeking an explanation for this puzzle. Acemoglu holds that the distribution of power matters, and those with the power often make change very difficult. Maybe England’s success is found in the long struggle between members of the aristocracy themselves, leading to a relatively more equitable distribution of power (even if only within a certain social class).

Another facet of institutional variation is that there is no ideal set of institutions that fits each and every social environment. For example, we have a tendency to argue that those countries which are relatively poor are so, because they have failed to adopt the same institutions as the wealthier, more developed nations. Allen, here, does contribute a very valuable, and often unacknowledged, insight: institutions can be efficient in one place, but inefficient in another. The constraints that condition the rules matter, and before we can advocate the adoption of one rule over another we have to carefully consider the environment. The various examples Allen looks at, apart from being fun to read about, put the point of institutional relativism in perspective. Modern institutions just would not have worked out in pre-modern England; society would have been worse off had they been prematurely developed.

This brings us to a related point: even if, say, democratic institutions are a standard all societies should work towards, the preconditions for an efficient democracy (or whatever other institutional set you seek to adopt) matter. Just like the inability to monitor effort conditioned the incentive structure of the pre-modern world, other constraints may condition the institutions of the world’s poorest societies. The argument is not that the poorest countries may have “efficient institutions,” but that the path towards institutional efficiency is more complicated than we think, and that we may not necessarily know what is efficient. For the institutions that we know have worked elsewhere to succeed, the relevant prerequisites have to develop first.

Although Allen does not make the connection explicitly, this is a theme that runs through the work of Friedrich Hayek, who emphasized spontaneous, rather than planned, order. Hayek was all too aware of the fact that the world’s brightest, always wanting to improve the world around them, are not always cognizant of their ignorance — a weakness only the omniscient avoid —, prone to ignore the various complications that always seem to break down the most elaborate plans. Institutions are complex systems, and complex systems rarely have easy solutions.

Douglas Allen’s The Institutional Revolution is an incredibly fun and interesting book to read. He interprets the various organizations and customs of the pre-modern era through an institutional lens, which allows him to make sense of what others thought to be nonsensical. His explanations will surprise you, but he makes his arguments convincingly. The reader is guaranteed to see the world from a different, more refined perspective — even if you are already aware of what institutions are and why they matter. Beyond the entertainment and wonder, however, Allen makes the much-needed point of caution: the merit of a system is oftentimes hidden in the details, and if we pass judgment too quickly we will likely fall into the trap of the fatal conceit.