“Why doesn’t this work?!?!? Oh, right, we’re in England.”
This is the explanation for any problem my Danish flatmate and I encounter. While she’s lived here for years and I just arrived, we both get frustrated over the way things work – or don’t – in the UK. Yesterday I tried to explain at least some of these problems to my flatmate using economic history: the two of us are living in a developing country. Or, since I don’t really like that term, let’s say we are living in a medieval economy.
In an essay I handed in recently, I argued that the process of economic development is the process of solving fundamental problems of exchange (FPOE), thereby moving towards a situation of optimal levels of exchange. FPOE is the technical term for what happens when trade does not take place due to a lack of trust.
For those of you who appreciate game theory:
In a Prisoner’s Dilemma or “game of trust”, A can choose to initiate exchange or not, and B can choose to cooperate (by fulfilling his side of the contract) or not cooperate. If there is no exchange, the payoff for both players is 0. If there is a successful exchange (B cooperates), both players will be better off. However, if B thinks not cooperating will get him a higher reward than cooperating, he has an incentive to cheat A, leaving A worse off than if there is no exchange. And if A thinks he is likely to be cheated, there will be no trade, leaving the game at a sub-Pareto-optimal equilibrium without an exchange.
In medieval times, in the absence of state institutions like courts, traders attempted to solve their trust issues among themselves. For example, according to the historian Greif, Maghribi traders of the eleventh-century Mediterranean developed an informal contract-enforcement mechanism based on multilateral relationships within a close-knit “coalition”. They could spread information about cheating agents and make sure they were not traded with again. Basically “If you cheat one of us, we will all boycott you.”
Institutions like the Maghribi coalition are relation–based. They are largely implicit, personal and formed outside of courtrooms. In contrast, most of our modern state institutions are rule-based: most transactions are based on impersonal and explicit agreements, and the state can impartially enforce contracts.
The point I would like to stress in this distinction is not the existence of a state to regulate a market. It is the possibility of enforcing contracts impersonally and impartially, rather than through reputation. A rule-based system allows for large-scale anonymous trade – so it favors economic development.
Yet even a state-controlled rule-based system has certain relational elements. Citizenship gives you access to a coalition that is certainly larger than the one organized by the medieval Maghribis – but it is a coalition none the less. When a British library asks for proof of a UK address before they let me in to their reading room, when setting up a UK bank account turns into a bureaucratic nightmare for foreign students, and when I have to pay six months rent in advance unless someone who owns property in the UK can vouch for me, it is because the UK is a coalition. There is an implicit agreement that the Prisoner’s Dilemma has been resolved in advance for permanent members of the UK club, while foreigners must negotiate on their own. When you leave your home coalition, you are plunged back into the market conditions of the Middle Ages.
(This is of course only made worse by the fact that there may be institutions to help you, but you are less likely to know about them than you are to know about institutions in your home country – which may explain why I find London increasingly practical and less ridiculous the longer I stay here.)
Medieval traders went from a situation where trade didn’t take place because it was literally impossible to move goods between people, to a situation where trade was possible, but didn’t happen because of a lack of trust. Today we can initiate trade with complete strangers – not just impartially and impersonally, but instantly – with one click on a touch screen. But «can» and «do» are not the same. We have resolved so many of the practical problems that limit trade, from transportation costs to language barriers to timing, that when we refrain from exchange now, it is almost always because of some lack of trust.
Despite our supposedly rule-based national and international institutions, we still act relationally. Recent research using simple web-based games shows how cooperation can remain stable in a large group if participants have some choice over who they interact with. When grouped together completely randomly, the participants cheated each other more and more, even though this left them worse off in total.
According to The Economist, international migrants use diaspora networks as modern day coalitions. They trust people on the other side of the globe, because they originally emigrated from the same home countries. These networks make cross-border trade easier, and they are not government-enforced.
The paradox for economic historians who study medieval times is that exchange took place without the assistance of a state regulating the market. A paradox for both scholars and policy-makers today is how exchange should take place in a globalized economy where one state can no longer regulate the entire market.