Extractive Institutions DefinedEXTRACTIVE INSTITUTIONS (p. 76): “We call such institutions, which have opposite properties to those we call inclusive, extractive economic institutions—extractive because such institutions are designed to extract incomes and wealth from one subset of society to benefit a different subset.”

Inclusive Institutions DefinedINCLUSIVE INSTITUTIONS (p. 74): “Inclusive economic institutions…are those that allow and encourage participation by the great mass of people in economic activities that make best use of their talents and skills and that enable individuals to make the choices they wish.

Simple view of Feudalism (and pre-capitalist societies)

Society consists of two groups Farmers (who grow food) Warriors (who protect food)

The farmers are the majority and provide society with food (and other resources)The warrior class – or at least, the leaders of the military – claim most of the resources.Or, the military extracts resources from the majority of society. And that means, society is defined by extractive institutions

Feudalism Defined (historical definition)Prior to capitalism, societies were dominated by extractive institutions. These institutions could be defended in terms of religion, tradition, or simple force.

In Europe, the extractive system employed after the fall of the Roman Empire has been called feudalism.

According to historian J.P. Somverville... The very definition of feudalism is debated, but roughly speaking a

feudal society is one where: Land is held in exchange for service Obedience is rendered in exchange for protection Society is hierarchically ordered with a military class of highly-

trained and expensively-equipped warriors supported by a mass of peasants who provide labor and are tied to the land.

Markets under Feudalism from Heilbroner (1999)

France. The year, 1305. It is a fair we visit. The traveling merchants have arrived this morning with their armed guard, have set up their gaily striped tents, and are trading among themselves and with the local population. A variety of exotic goods is for sale: silks and taffetas, spices and perfumes, hides and furs.

Some have been transported from the Levant, some from Scandinavia, some from only a few hundred miles away. Along with the common people, local lords and ladies frequent the stalls, eager to relieve the tedium of their boring, drafty, manorial lives; they are eagerly acquiring, along with the strange goods from Araby, new words from that incredibly distant land: divan, syrup, tariff, artichoke, spinach, jar.

But inside the tents, we meet with a strange sight. Books of business, open on the table, are sometimes no more than notebooks of transactions; a sample extract from one merchant reads: “Owed ten gulden by a man since Whitsuntide. I forgot his name.” Calculations are made largely in Roman numerals, and sums are often wrong; long division is reckoned as something of a mystery, and the use of zero is not clearly understood.

And for all the gaudiness of the display and the excitement of the people, the fair is a small thing. The total amount of goods which comes into France in a year over the Saint Gothard pass (on the first suspension bridge in history) would not fill a modern freight train; the total amount of merchandise carried in the great Venetian fleet would not fill one modern steel freighter.

Markets under Feudalism from Heilbroner (1999)

Germany. The year, 1550 odd.

Andreas Ryff, a merchant, bearded and fur-coated, is coming back to his home in Baden; he writes in a letter to his wife that he has visited thirty markets and is troubled with saddle burn. He is even more troubled by the nuisances of the times; as he travels he is stopped approximately once every ten miles to pay a customs toll; between Basle and Cologne he pays thirty-one levies.

And that is not all. Each community he visits has its own money, its own rules and regulations, its own law and order. In the area around Baden alone there are 112 different measures of length, 92 different square measures, 65 different dry measures, 163 different measures for cereals and 123 for liquids, 63 special measures for liquor, and 80 different pound weights.

Markets under Feudalism

from Heilbroner (1999)

Boston in the year 1639.

A trial is in progress; one Robert Keayne, “an ancient professor of the gospel, a man of eminent parts, wealthy and having but one child, and having come over for conscience’ sake and for the advancement of the gospel,” is charged with a heinous crime: he has made over sixpence profit on the shilling, an outrageous gain. The court is debating whether to excommunicate him for his sin, but in view of his spotless past it finally relents and dismisses him with a fine of two hundred pounds. But poor Mr. Keayne is so upset that before the elders of the Church he does “with tears acknowledge his covetous and corrupt heart.” The minister of Boston cannot resist this golden opportunity to profit from the living example of a wayward sinner, and he uses the example of Keayne’s avarice to thunder forth in his Sunday sermon on some false principles of trade.

Among them are these: That a man might sell as dear as he can, and buy as cheap as he can. If a man lose by casualty of sea, etc., in some of his commodities, he may raise the

price of the rest. That he may sell as he bought, though he paid too dear ... All false, false, false, cries the minister; to seek riches for riches’ sake is to fall

into the sin of avarice.

Markets under Feudalism

from Heilbroner (1999)

France in 1666

There has been entirely too much initiative displayed of late by the weaving industry… Henceforth the fabrics of Dijon and Selangey are to contain 1,408 threads including selvages, neither more nor less. At Auxerre, Avallon, and two other manufacturing towns, the threads are to number 1,376; at Châtillon, 1,216. Any cloth found to be objectionable is to be pilloried. If it is found three times to be objectionable, the merchant is to be pilloried instead.

Heilbroner Summarizedfrom Heilbroner (1999)

There is something common to all these scattered fragments of bygone worlds. It is this: first, the idea of the propriety (not to say the necessity) of

a system organized on the basis of personal gain has not yet taken root.

second, a separate, self-contained economic world has not yet lifted itself from its social context. The world of practical affairs is inextricably mixed up with the world of political, social, and religious life.

Age of Modern Man?

from Heilbroner (1999)

It may strike us as odd that the idea of gain is a relatively modern one; we are schooled to believe that man is essentially an acquisitive creature and that left to himself he will behave as any self-respecting businessman would. The profit motive, we are constantly being told, is as old as man himself. But it is not. The profit motive as we know it is only as old as “modern man.”

Sir William Petty, an astonishing seventeenth-century character (who was in his lifetime cabin boy, hawker, clothier, physician, professor of music, and founder of a school named Political Arithmetick), claimed that when wages were good, labor was “scarce to be had at all, so licentious are they who labor only to eat, or rather to drink.”

And Sir William was not merely venting the bourgeois prejudices of his day. He was observing a fact that can still be remarked among the unindustrialized peoples of the world: a raw working force, unused to wagework, uncomfortable in factory life, unschooled to the idea of an ever-rising standard of living, will not work harder if wages rise; it will simply take more time off.

The idea of gain, the idea that each working person not only may, but should, constantly strive to better his or her material lot, is an idea that was quite foreign to the great lower and middle strata of Egyptian, Greek, Roman, and medieval cultures, only scattered throughout Renaissance and Reformation times; and largely absent in the majority of Eastern civilizations. As a ubiquitous characteristic of society, it is as modern an invention as printing.

THOMAS MUN (1571-1641)

1. A leading mercantilist specifically named by Smith

2. Director of the East India Company

3. Authored “England’s Treasure by Foreign Trade”

Confused the wealth of a nation with its stock of precious metals.

Favored government regulation of trade so that a favorable balance could be achieved.

Encourage importation of cheap raw materials

Encourage export of manufactured goods

Enact protective tariffs on imports of manufactures

Take measure to increase population and keep wages low

SUMMARIZING MERCANTILIST THOUGHT

1. Following the scholastics, who assumed the gain of one person via trade was another person’s loss the mercantilist’s assumed the total wealth of the world is fixed. Was this a reasonable assumption in this time period?

2. Exchange between nations via international trade was thus a zero-sum game. Again, is this reasonable?

3. Goal of economic activity was production, not consumption.

4. Wealth of nation was increased via increased production, increased exports, and decreased domestic consumption. In other words, maximize the difference between exports and imports.

5. A nation should encourage exports viaa) government encouragement of domestic production

b) acquisition of cheap raw materials via imports

c) maintaining low wage levels

6. Imports should be discouraged via tariffs, quotas, subsidies, and taxes

7. A “favorable” balance of trade will lead to an increase in a nation’s stock of precious metals, which is how a nation’s wealth was defined.

8. Low wages were encouraged to make exports more competitive.

9. High wages discouraged workers from working long hours. i.e. backward bending labor supply curve. Again, is this a reasonable assumption?

WILLIAM PETTY (1623-1687)

1. Authored “Political Arithmetic”

2. Advocated the use of statistical techniques to measure social phenomena

3. Petty’s methodology was counter to the literary methodology generally practiced.

4. for more, see http://www.ucl.ac.uk/~uctpvhg/IDSHPE/McCormick%20HSS%20Paper%20c%20fmtd%20smaler.pdf

BERNARD MANDEVILLE (1670-1733)1. Authored “Fable of the Bees; Or, Private Vices, Public Benefits”

http://martinfrost.ws/htmlfiles/bees_fable.html#Hive The MORAL.

THEN leave Complaints: Fools only striveTo make a Great an honest Hive. [410]

T'enjoy the World's Conveniencies,Be famed in War, yet live in Ease

Without great Vices, is a vainEutopia seated in the Brain.

Fraud, Luxury, and Pride must live; [415]We [illeg.] we the Benefits receive.

Hunger's a dreadful Plague no doubt,Yet who digests or thrives without?Do we not owe the Growth of Wine

To the dry, crooked, shabby Vine? [420]Which, whist its [illeg.] neglected flood,Choak'd other Plants, and ran to Wood;

But blest us with his Noble Fruit;As soon as it was tied, and cut:

So Vice is beneficial found, [425]When it's by Justice [illeg.], and bound;Nay, where the People would be great,

As necessary to the State,At Hunger is to make 'em eat.

Bare Vertue can't make Nations live [430]In Splendour; they, that would revive

THOMAS HOBBES (1588-1679)1. In the absence of morality, life is “nasty, brutish, and

short” as people’s pursuit of wealth leads to unrestrained conflict

2. Solution is a social contract where by a government is given the power to to protect individual rights

3. Social contract details:a) must be by universal consent to avoid oppressionb) government must serve the interest of the peoplec) Hobbes opposes divine right to powerd) Hobbes envisions an authoritarian state designed to

promote social order.

4. The extent of this state has been rejected by subsequent classical liberals

THEORETICAL CONTRIBUTIONS OF THE MERCANTILISTS

1. Government policy could influence economic events.

2. Government policy should not interfere with basic economic truths such as supply and demand.

3. Government must take people’s selfish motives as given.

4. Unlike Adam Smith, though, these writers generally saw a conflict between private interests and public welfare.

5. Later mercantilists recognized the fallacy a) of measuring a nation’s wealth by its holdings of specieb) that all nations could have a favorable balance of trade.c) of any one nation have a favorable balance of trade in the long run.d) of trade being a zero-sum game.

6. Mercantilists also believed in the non-neutrality of money, an idea rejected in Classical thought, but accepted by Keynes.

DAVID HUME (1711-1776)1. David Hume introduced the price-specie flow mechanism,

which demonstrated that the Mercantilist focus on a favorable balance of trade could not be a nation’s long-run objective

a) Favorable balance of trade would increase the flow of gold and silver (specie) into the economy.

b) The increased money supply would increase the level of price.c) Higher prices will lead to a decline in exports and an increase in imports.d) For nations with an unfavorable balance of trade, the opposite would

occur. e) Thus no nation could maintain a favorable balance of trade in the long run.

2. Hume accepted a mercantilist idea that increases in the money supply could lead to increases in output.

3. Hume believed that economic and political freedom went together

4. Hume’s Dictum: “That what ought to be cannot be derived from what is” (i.e. positive statements cannot be derived from normative statements)

PHYSIOCRACY1. History of the movement

a) Existed in France from 1750-1780

b) The leader was Francois Quesnay (1694-1774)

c) Focus was on the economic development of France

2. Basic Ideasa) Natural Law: Laws existed independent of human will that governed the operation of the economy.

b) Interrelatedness of an economy

c) Rejected the mercantilist notion that wealth was a result of exchange.

d) Physiocrats believed that wealth was derived from agriculture.

i. Introduced the idea of the “net product”, or the surplus after costs are paid.

ii. Asserted that only land produced the “net product”. All other factors could only cover their costs.

iii. Believed that manufacturing was “sterile”. This proposition must be examined relative to the economic conditions of France at the time.

iv. First to present a model representing the circular flow of the economy. Participants: Farmers, Landowners, Artisans. http://www.econlib.org/library/Smith/tableau1.jpg

v. Physiocratic Economic Policy: “laissez-faire”.

For more on Physicrats (and Cantillion), see http://web1.boisestate.edu/econ/lreynol/web/PDF_HET/Physiocratsoutline.pdf

PHYSIOCRATS AND MERCANTILISM http://www.econlib.org/library/Enc/bios/Quesnay.html

François Quesnay was the leading figure of the Physiocrats, generally considered to be the first school of economic thinking. The name “Physiocrat” derives from the Greek words phýsis, meaning “nature,” and kràtos, meaning “power.” The Physiocrats believed that an economy’s power derived from its agricultural sector. They wanted the government of Louis XV, who ruled France from 1715 to 1774, to deregulate and reduce taxes on French agriculture so that poor France could emulate wealthier Britain, which had a relatively laissez-faire policy. Indeed, it was Quesnay who coined the term “laissez-faire, laissez-passer.”

he was right in ascribing France’s poverty to MERCANTILISM, which he called Colbertisme (after Louis XV’s finance minister, Jean-Baptiste Colbert). The French government had protected French manufacturers from foreign COMPETITION, thus raising the cost of machinery for farmers, and had also sold to wealthy citizens the power to tax farmers. These citizens had then used this power to the limit.

Quesnay advocated reforming these laws by consolidating and reducing taxes, getting rid of tolls and other regulations that prevented trade within France, and generally freeing the economy from the government’s stifling controls. These reforms were much more sensible than his theorizing about the sterility of industry. As Mark Blaug writes, “It was only the effort to provide these reforms with a watertight theoretical argument that produced some of the forced reasoning and slightly absurd conclusions that invited ridicule even from contemporaries.”