I’ve thoroughly enjoyed [amazon_link id=”0226014746″ target=”_blank” ]The Institutional Revolution[/amazon_link] by Douglas W Allen, although it wasn’t what I had been expecting. The book combines a fascinating institutional economics descriptive approach to some specific historical institutions, in Britain of the 17th to 19th centuries with some highly thought-provoking analysis of the way technology changes social and economic institutions. As noted in my curtain raiser, the book analyses some specific institutions that on the face of it look inefficient or even irrational from the perspective of transactions costs. So much of life was subject to the vagaries of nature that measuring a person’s effort was impossible. Meritocracy was therefore impractical – the measurement/transactions costs were too high. Instead, the ruler – the king in this case – exerted power through institutions that forced people to demonstrate loyalty in order to access wealth, or institutions that in some way aligned private incentives with those of the monarch.

For example, the very existence of the aristocracy as a ruling class – small and immensely wealthy – was due to this need to demonstrate loyalty. People who would enter from the lesser gentry or climb the aristocratic ranks had to make large investments in social capital such as building a large and fairly isolated country estate, taking part in the right dances and teaching the daughters of the house music and needlework, mingling only with the right sort of people. All very Jane Austen. The reward would be offices handed out by patronage, giving access to what we might see as bribes but were then simply the income for the job. Disloyalty resulted in social ostracism. All that ‘sunk’ social capital would go to waste and the source of income gone. It was, he argues, an economically efficient system: “Britain, by becoming the most aristocratic of societies, also became the wealthiest and most powerful.” (p79)

Allen sees duelling in the same light. It would be social death not to challenge to a duel somebody who accused one of lying or dishonourable behaviour, but there were strict conventions about the weapons and format. It had to be impossible not to take the risk of a duel if one wanted to hang on to that social capital, with enough danger of death to discourage pretenders but not enough danger of death that duels were frequently fatal. Drawing blood was usually enough to win.

He goes on to look at other institutions from the same transactions cost perspective, from the rules for joining and promotion as an officer in the army and navy, to the justice system and policing, to lighthouses.

Technology changed everything. “In modern times, our ability to measure service performance allowed for the development of bureaucratic institutions.” For instance, until the 19th century, lighthouses were all privately run because all ships sailed close to shore for much of the time, so poor was navigation and control over sailing ships. Every vessel used the lighthouses, so every one paid lighthouse dues to the company when they put in to harbour. The combination of measuring longitude and steam power changed sailing in such a way that many ships did not have to put into harbour, and it was not possible to tell who was and who was not using the lighthouse services. Therefore a free rider problem emerged, and lighthouses became public goods as we conventionally think about them.

The changing technology of the Industrial Revolution – reliable timekeeping, rail travel, steam power – changed the economically efficient shape of the institutional landscape across the board. “The problem was that the evolution of institutional responses, which allowed for the full exploitation of technological advances, took time to develop.” (p222) The economic benefits of technological change were therefore slow – something we have seen in our own times with the full impact of the information and communications revolution. But when they do come along, they have spillover effects, and economic change is rapid.

Allen doesn’t speculate about today, but I found it impossible to resist. Bureaucratic administration, which we still have, was ideal for the mass production economy in which goods and services are standardised and an individual’s effort easy to monitor. Increasingly, though, the new technologies mean computers are doing the things that are standardised and measurable, and people are once again doing work where their effort is hard to monitor, whether that is writing large computer programmes or devising an advertising campaign or caring for an elderly person. [amazon_link id=”0691145180″ target=”_blank” ]I’ve argued before[/amazon_link] that we have institutions that lag behind our technologies. This book really helped me understand the shapes institutions can take when there are specific kinds of measurement and transactions costs. The emerging high trust economy will end up being governed in ways that look revolutionary from today’s perspective.

[amazon_image id=”0226014746″ link=”true” target=”_blank” size=”medium” ]Institutional Revolution: Measurement and the Economic Emergence of the Modern World (Markets and Governments in Economic History)[/amazon_image]

There’s an interesting post on GigaOM predicting a rosy future for e-books. Its author, Trey Ratcliff, cites the attraction of much higher profit margins, thanks to disintermediation, the fact that readers do not substitute e-books for physical books one-for-one (hello, record and movie companies!!), and the marketing power of social media. His own experience of moving from authorship to e-book publishership was one of rapid revenue and profit growth. Lucky him – he obviously started from the base of a large online presence.

I’ve got no idea if I should agree with his forecast of the scale of likely growth. But I do think book publishers have learned some lessons from the terrible example set by the record companies, and they are innovating around what customers seem to want. However, the biggest likely stumbling block to an ultra-rapidly growing e-book market will be the bottleneck of the giant distribution platforms and their charging policies. That surely promises to be a fascinating anti-trust case down the road?

I’m well along with Douglas Allen’s new book, [amazon_link id=”0226014746″ target=”_blank” ]Institutional Revolution: Measurement and the Economic Emergence of the Modern World (Markets and Governments in Economic History)[/amazon_link]. A full review will follow in due course but I can’t resist enthusing about it in advance. The book takes a transactions cost perspective on the shift in institutional structures between the early 18th and late 19th centuries, as Britain hurtled through the Industrial Revolution. The key, Allen argues, was the way the technologies helped greatly reduce the uncertainty of life as people gained more and more control over nature. This made it possible to distinguish rather better between bad luck and low effort, previously an impossible measurement task, and therefore to reward merit in administrative jobs rather than having to build institutions that guaranteed loyalty. Thus government by the aristocracy gave way to the growth of the bourgeois professions. Fascinating stuff, with an obvious extension to developing countries today – and perhaps our own economy too as in the frontier intangible activities such as building software or creating hit movies it is also very hard to distinguish talent from luck. Are trust institutions, like the old British aristocracy but different, going to make a comeback?

[amazon_image id=”0226014746″ link=”true” target=”_blank” size=”medium” ]Institutional Revolution: Measurement and the Economic Emergence of the Modern World (Markets and Governments in Economic History)[/amazon_image]

In Keynes’s marvellous [amazon_link id=”0230249574″ target=”_blank” ]Essays in Persuasion[/amazon_link] are a couple of open letters of advice to the French minister of finance (“whoever he is, or may be”). Of course the context of the times (1926 and 1928) was entirely different from today’s crisis, but it isn’t entirely fanciful to consider some similarities between the gold standard and the Euro. I will let Keynes speak for himself:

“When I read in my daily paper the projects of yourself and your predecessors to draft new budgets and to fund old debts, I get the impression that Paris discusses very little of what seems to me in London to be the technical analysis of your problem…. the proportion of his earned income which the French taxpayer will permit to be taken from him to pay the claims of the French rentier.”

Substitute ‘European’ for ‘French’, and the same question is at the heart of how the Euro debt crisis is to be resolved. The essence of Keynes’s advice in the 1920s was to inflate away the real value of the debt burden. He concludes, optimistically,

“France has abandoned principle and consistency alike, but she has always refused sacrifices which were avoidable and has obeyed in the end the teachings of experience.”

It’s worth noting, though, that the late 1920s were exactly the period when France accumulated large amounts of gold reserves, sterilising the impact on domestic demand. Douglas Irwin (pdf) has suggested that this policy was an important cause of the Great Depression.

Who can say what Keynes would advise President Sarkozy to do in today’s different circumstances. But I think it certain he would work out how best to ensure it is the rentiers, rather than the workers and taxpayers who end up suffering.

[amazon_image id=”0230249574″ link=”true” target=”_blank” size=”medium” ]Essays in Persuasion[/amazon_image]

When are groups better than individuals at solving problems? When is collective intelligence better than individual intelligence? It’s a question that has long interested me, partly because of personal experience. Some group and committee work has been stimulating and fruitful (for example, being a member of Competition Commission inquiry groups), some dull and producing only group-think. I had a hunch that bringing together people from different professional disciplines and walks of life was a positive (even if only economists, lawyers, accountants, business executive), when they shared a common goal. This seemed to be confirmed by a marvellous book, [amazon_link id=”0691138540″ target=”_blank” ]The Difference: How The Power of Diversity Creates Better Groups, Firms, Schools and Societies[/amazon_link], by Scott Page, about the importance of diversity for good decision-making.

I’ve just been reading another interesting book, this time about the broader collective intelligence enabled by the internet. It’s [amazon_link id=”0691148902″ target=”_blank” ]Reinventing Discovery: The New Era of Networked Science[/amazon_link] by Michael Nielsen, a quantum computing pioneer. He too notes the power of people pooling their information and perspectives, with the internet as a driver of networked discovery (although another factor must be just that as the body of discovery grows ever-larger, the proportion that can be known by any individual grows ever-smaller).

The book is focused on science rather than business or economics, and in particular on the tension between the genuine collaboration taking place in a few scientific projects (one example is Galaxy Zoo, exploring the universe using volunteers, and the Polymath Project) and the career and financial imperatives on scientists to keep their results secret. His frustration at the scientific community’s failure to take advantage of the massive potential offered by collaboration via the internet leaps off the page. He writes:

“Network science is being strongly inhibited by a closed scientific culture that chiefly values contributions in the form of scientific papers. Knowledge shared in non-standard media isn’t valued by scientists regardless of its intrinsic value, and so scientists are reluctant to work in such media.” (p182)

He also flags up in passing the issue about the frequent imperative either to commercialize results or to keep them secret for the benefit of commercial funders.

The situation in economics is different in interesting ways. Promotion in the university system still hinges on publishing papers in the right journals. But economists have lots of other job prospects, or additional income from consulting if they are academics, so their external reputation is important as well as their academic status. This is perhaps why an active part of the discussion about economic research takes place online, thanks to its now-standard publication as a working paper before formal publication in a journal, and also via blogs. What’s more, non-academics can take part in a debate about economics (or other social sciences or the humanities), whereas university-based science is too hard for most non-academics. This suggests that changing university career structures will be important for opening up science – incentives really matter. Both the sciences and economics would benefit from ‘official’ acknowledgement in promotion structures of a wider range of journals and other evidence of success (including teaching!).

Nielsen hopes to achieve his “goal of lighting an almighty fire under the scientific community.” I hope he succeeds. A lot of the scientists I know would share his strong commitment to open access research. Moreover, big science is funded by taxpayers. While governments do want to see some research deliver new businesses and economic growth, and therefore the intellectual property tightly held, they will surely want the rest – certainly the basic science – made widely available. His book is well worth a read by anyone interested in these important issues of openness – which the internet is forcing to the top of the agenda in many domains – and diversity.

[amazon_image id=”0691148902″ link=”true” target=”_blank” size=”medium” ]Reinventing Discovery: The New Era of Networked Science[/amazon_image]

Here are some other reviews – Scientific American blog, THES, The Financial Times.