ForexampleLaPortaetalKeeferandKnackEasterlyandLevineForexampleMilgrometalNorthGreifForexampleRolandAokiQianNSchoeldandGCaballeroedsPoliticalEconomyofInstitutionsDemoc ID: 498104
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Institutions:RulesorEquilibria?AvnerGreifandChristopherKingston1IntroductionInrecentyears,theinterestinrationalchoiceanalysisofinstitutionshasreceivedsubstantialimpetusfromanaccumulatingbodyofevidencedemonstratingtheimportanceofasocietysinstitutionsindeterminingitseconomicoutcomes.Econo-metricstudieshaveuncoveredcorrelationsbetweeninstitutionalvariablessuchasthesecurityofpropertyrights,theruleoflaw,andtrust,andeconomicandpoliticaloutcomesincludinglevelsofproduction,saving,andcorruption.Historicalstudieshaverevealedtherolethatinstitutionsplayedinlong-runtrajectoriesofindustrialandcommercialdevelopment.Studiesofthedevelopingworldandofcountriestransitioningfromsocialismhaverevealedthechallengesinvolvedincreatingwell-functioninginstitutions,thebenetsthatcanbeobtainedwheninstitutionalchangeandeconomicreformaresuccessful,andthedangersthatensuewhentheyarenot.Stimulatedbythesedevelopments,theconceptualframeworksemployedbyscho-larsstudyinginstitutionshavealsobeenevolving,asoldframeworkshavebeenadaptedandnewframeworkshaveemergedtoexploreoldandnewquestionsabouthowinstitutionsfunction,howtheychange,andhowtheyaffecteconomicbehaviorandoutcomes.Therational-choiceapproachtoinstitutionalanalysisdoesnotrequireustoassumethatpeoplearealwaysrational,orthatinstitutionsarechosenrationally.Rather,itholdsthatarational-choiceperspectiveenablesustogenerateatheorywithempiri-callyrefutablepredictionsabouttheinstitutionsthatcanprevailinagivensituation.A.Greif(DepartmentofEconomics,StanfordUniversity,Stanford,CA94305,USAe-mail:avner@stanford.eduC.KingstonDepartmentofEconomics,AmherstCollege,AmherstMA01002,USAe-mail:cgkingston@amherst.edu Forexample,LaPortaetal.(),KeeferandKnack(),EasterlyandLevine(Forexample,Milgrometal.(),North(),Greif(Forexample,Roland(),Aoki(),Qian(N.SchoeldandG.Caballero(eds.),PoliticalEconomyofInstitutions,DemocracyandVoting,DOI10.1007/978-3-642-19519-8_2,Springer-VerlagBerlinHeidelberg2011 Thisinvolvestwokeyquestions:rst,howinstitutionsareselectedandsecond,howpeoplearemotivatedtofollowinstitutionalizedpatternsofbehavior.Onestrandofthoughtwithintherational-choiceapproachtoinstitutionalanalysis,theso-calledinstitutions-as-rulesapproach,emphasizestheimportanceofatheoryofselectionofinstitutions,whileanemergingalternativeapproach,theinstitutions-as-equilibrialineofanalysisemphasizestheimportanceofatheoryofmotivation.Theinstitutions-as-rulesapproach,followingNorth(,p.3),identiesinstitutionsastherulesofthegameinasociety,includingbothformalrulessuchasconstitutionsandlawsenforcedbythestate,andinformalconstraintssuchascodesofconduct,normsofbehavior,andconventions,whicharegenerallyenforcedbythemembersoftherelevantgroup(North,,p.36).Manykindsofformalrulesareselectedthroughacentralizedprocessofbargainingandpoliticalconictbetweenindividualsandorganizationswhoattempttochangetherulesfortheirownbenet.Inothercases,formalorinformalrulesmaybeselectedinadecentralizedwaythroughevolutionarycompetitionamongalternativeinstitutio-nalforms.Ineithercase,theinstitutions-as-rulesviewholdsthatinstitutionsareultimatelybestunderstoodfromafunctionalistperspectivethatrecognizesthattheyareresponsivetotheinterestsandneedsoftheircreators(althoughthereisnoguaranteethattherulesselectedwillbeefcient).Withintheinstitutions-as-rulesview,theenforcementoftherulesisconsideredasadistinctissuefromtheformationandcontentoftherulesthemselves.Enforcingtherulesinvolvesenforcementcosts.Theformalandinformalrules,togetherwiththeirenforcementcharacteristicsconstitutetheinstitutionalstructurewithinwhichinteractionsoccur.Thus,theinstitutions-asrulesapproachemploysarational-choiceperspectivetostudytheformationofinstitutions,butatheoryofmotiva-tionexplainingpeoplefollowparticularrulesofbehaviorisnotintegratedintotheanalysis.Agrowingbodyofrecentresearchoninstitutionsplacesatheoryofmotivationatthecenteroftheanalysis,andtherebyendogenizestheenforcementoftherules,bystudyinginstitutions-as-equilibria.Thisperspectivefocusesonhowinteractionsamongpurposefulagentscreatethestructurethatgiveseachofthemthemotivationtoactinamannerperpetuatingthisstructure.Togiveasimpleexample:intheUnitedStates,people(nearlyalways)driveontheright-handsideoftheroad.Thisregularityofbehaviorgeneratesexpectationsthatmotivatethebehavioritself:peopledriveontherightbecausetheyexpectotherstodoso,andwishtoavoidaccidents.Ofcourse,itisalsoarulethatonemustdriveontheright.However,manyalternativetechnologicallyfeasiblerules(forexample,womendriveontherightandmenontheleft)wouldgenerateexpectationswhichwouldfailtomotivateapatternbehaviorconsistentwiththerule:thatis,suchpatternsofbehaviorarenotequilibria,andeveniftheywereformallyspeciedasarulewewouldnotexpectthemtoemergeasinstitutions,becausetherulewouldnotbeself-enforcing.Foreveryonetodriveontheright,however,isoneoftwopotentiallyself-enforcingruleswhichcouldemerge(orbeenacted)asanequilibrium.Thecrucialpointisthatwhilearulemayserveasacoordinationdevice,itisfundamentallytheexpectedbehaviorofothers,ratherthantheruleitself,which14A.GreifandC.Kingston motivatespeoplesbehavior.Asimilarlogiccanbeusedtoexamineeconomic,political,andsocialinstitutionseveninsituationsinvolvingspecializedactorsandmorecomplexformalrules.Fromtheinstitutions-as-equilibriaperspective,itisalwaysultimatelyexpectationsaboutthebehavioroftheotheractors(includingthoseinspecializedenforcementrolessuchaspolice,judges,etc.)thatcreatetheinstitutionalconstraintswhichmoldpeoplesbehavior,andallsuchbehaviormustthereforeultimatelybeexplainableendogenouslyaspartoftheequilibrium.Despitetheirdifferences,theinstitutions-as-rulesandinstitutions-as-equilibriaapproacheshavemuchincommonandarebestviewedascomplementsratherthansubstitutes.Bothseektoadvanceapositiveanalysisofthenon-technologicaldeter-minantsoforderandregularitiesofhumanbehavior.Recentadvancesintheliteraturecombineelementsofthetwoperspectives.Thischaptersurveysthesedevelopmentsandhighlightspromisingdirectionsforfutureresearch.Aswewilldiscuss,theinsti-tutions-as-rulesframeworkhasbeenfruitfullyappliedtoshedlightontheemergenceandfunctioningofavarietyofinstitutions,includingcommunities,organizations,andpoliticalandlegalinstitutions.However,wewillarguethatbyendogenizingtheissueofenforcement,theinstitutions-as-equilibriaapproachenablesamoresatisfactorytreatmentofseveralkeyissues,includingpromotingourunderstandingofprocessesofinstitutionalchange.2InstitutionsasRules:ConceptualIssuesAsdiscussedabove,themostcommonlyciteddenitionofinstitutionsisthatadvancedbyDouglassNorth:institutionsaretherulesofthegameinasociety,ormoreformally,arethehumanlydevisedconstraintsthatshapehumaninteraction(North1990,p.3).Institutionsincludebothformalrules,whichareexplicit,writtenrulessuchaslawsandconstitutions,andinformalconstraintssuchasconventionsandnorms.InNorthstheory,formalrulesarecreatedbythepolity,whereasinformalnormsareapartoftheheritagethatwecallculture(p.37)andthereforeimpervioustodeliberatehumandesign.Thefocusoftheanalysisisthereforeonformalrules,namely,rulesthatareexplicitlyandintentionallycreated.Toillustratetheinstitutions-as-rulesapproach,considertheframeworkdevelopedbyOstrom(2005),whoenvisagesahierarchywithseverallevelsofrules:operationalruleswhichgovernday-to-dayinteractions;collective-choicerules,whicharerulesforchoosingoperationalrules;constitutionalrules(rulesforchoosingcollective-choicerules);metaconstitutionalrules(rulesforchoosingconstitutionalrules);andatthehighestlevel,thebiophysicalworld(p.58).Thatis,eachlevelinthis Forarecentdiscussion,seeGreif().KingstonandCaballero()surveytheoriesofinstitutionalchange.North(,p.47)envisagesasimilarhierarchywithfourlevelsofformalrules:constitutions,statuteandcommonlaws,specicbylaws,andindividualcontracts.Institutions:RulesorEquilibria?15 hierarchyofrulesconsistsofrulesthatgovernhowrulesatthelowerlevelarecreated.Forexample,constitutionalandcollective-choicerulesprovidethestruc-turethatgovernsthechoiceofoperationalrules.Higher-levelrulesarealsomoredifcultandcostlytochange.Whentheyperceivethatexistingrulesgoverningtheirinteractionsatonelevelareunsatisfactory,individualsaredriventoshiftlevelsandtrytochangetherules.Apoliticalbargainingprocessensues.Eachindividualcalculatestheirexpectedcostsandbenetsfromanyproposedinstitutionalchange,andaninstitutionalchangecanoccuronlyifaminimumcoalitionnecessarytoeffectchangeagreestoit.Whatconstitutesaminimumcoalitionisdeterminedbythehigher-levelrules;forexample,inademocracy,amajoritywouldconstituteaminimumwinningcoalition;inadictatorshipthedictatoralonemightconstituteaminimumcoalition.Therefore,thesetofrulesthatultimatelyemergeswilldependontheperceivedinterestsoftheactorsinvolvedinsettingtherules,ontheabilityofvariousinterestgroupstoactcollectivelytomaketheirinterestscount(Olson),andonthehigher-levelrulesthatdeterminehowthoseindividualinterestsareaggregated.Thereisnoguaranteethatthisprocesswillleadtotheselectionofefcientrules.Inmanycases,thosewithpoliticalpowermaytrytoselectrulestogeneratedistribu-tionalbenetsforthemselves;thatis,tomaximizetheirwelfareratherthanthatofsocietyasawhole.Toexplainwhysocietieschooseinefcientinstitutions,how-ever,itisnotsufcienttonotethatthegroupsinpowerhaveintereststhatdivergefromtherestofsociety.Ifaninstitutionalchangecouldincreaseefciencyandeconomicoutput,whycannotthebeneciariesofthechangeagreetoredistributethegainstocompensatethelosers?Acemoglu(2003)arguesthatthekeyproblemiscommitment:thepowerfulcannotcrediblycommitnottousetheirpowerfortheirownbenetastheopportunityarises,andothergroupscannotcrediblycommittocompensatethepowerfulforgivinguptheirpower.Asaresult,thesetofbargainswhichcanbestruckisrestrictedtothosebargainswhichcanbesustainedasequili-briumoutcomes(Fearon2007;Greif19982006).Becausethereisnoexternalauthoritytoenforceinter-temporalbargains,politicallypowerfulgroupsmayblockchangesthatwouldbebenecialoverall,orimposeinefcientchangesthatbenetthemselvesattheexpenseofothers.Fundamentally,therefore,asatisfactoryunder-standingoftheseaspectsofinstitutionalchangerequiresarecognitionthattheprob-lemisnotjustchoosingnewrules,butthemorerestrictiveproblemofengineeringamutuallybenecialshifttoanew,self-enforcingequilibrium.Wewillreturntothisissuelater.Asecond,complementarystrandofthoughtwithintheinstitutions-as-rulesapproachviewsthedevelopmentofrulesasanoutcomeofevolutionarycompeti-tionamongalternativeinstitutionalforms.Alchian()arguedthatcompetitivepressureweedsoutinefcientformsoforganizationamongrmsincompeti-tivemarkets,becausermsthatdevelopmoreefcientorganizationalformswillbemoreprotable,andtheuseoftheserulesandformsoforganizationwillthere-foretendtospreadthroughgrowthorimitation.Demsetz()extendedtheevo-lutionaryargumenttothedevelopmentofproperty-rightsrules,hypothesizingthattheserulesdevelopandadjustasaresultoflegalandmoralexperimentswhich16A.GreifandC.Kingston maybehit-and-missprocedurestosomeextent,butwhichonlyproveviableinthelongruniftheygenerateefcientoutcomes.Hayek(1973)arguesthatgroupsororganizationsthat,byaccidentordesign,developlessefcientruleswillnotsur-vivecompetitionwithgroupsthatdevelopmoreefcientrules.Therefore,throughgroupselection,ruleswillevolvetowardsoptimality.TheevolutionaryapproachndsitsmostprominentmodernexpressioninOliverWilliamsonsTransactionscosteconomics(TCE).Accordingtothisview,trans-actioncostsariseinmanytransactionsbecauseoftheboundedrationalityandopportunismofthetransactingparties(Williamson2000).Dependingontheattri-butesofaparticulartransaction,somesetsofrules(governancestructures)willleadtomoreefcientoutcomesthanothers.Thetransactions-costeconomicsapproachassumesthatthemostefcientinstitutionalforms(thosewhichminimizetrans-actionscosts)willemerge.So,forexample,ifachangeinproductiontechnologyrendersexistinginstitutionsinefcient,thenovertime,new,moreefcientinstitu-tionalformswillemergetoreplacethem.Althoughthepolitical-designandevolutionaryapproachesenvisagequitediffer-entprocessesfortheselectionofrules,thetwostrandsofresearcharebestviewedascomplementary.Bothtreatinstitutionsassetsofrules(orgovernancestructures);andbothfocusonhownewrulesareselectedratherthanhowtheyareenforced.Differentinstitutionsareassociatedwithdifferenttransactioncosts,includingmonitoringcostsandenforcementcosts,butthenatureofthesecostsisnotpartoftheanalysis.TheconceptoftransactionscostsiswidelyusedinNewInstitutionalEconom-ics.Thetermisgenerallyusedverybroadlytoincludethecostsofndingtradingpartners,negotiatinganddrawingupcontracts,monitoringcontractualpartnersbehaviorandenforcingagreements,andothercostsincurredinanefforttodene,measureandenforcepropertyrightsoragreementstoexchangepropertyrights.Transactioncostsmayalsoincludethecostsofpoliticalactivity,bargaining,legalaction,andsooninvolvedindeliberateeffortstocreatenewrules,thecostsofinefciencyresultingfromcommitmentproblemsandotherformsofpoliticaltrans-actioncosts,aswellasallthecostsinvolvedinsettingup,maintainingandchangingthestructureofrulesandorganizations,andmonitoringtheactionsoftheagentsgovernedbythoserules.Inshort,anydifferencebetweenthevalueofoutputgene-ratedintherealworld,wherearealtransactionisgovernedbyrealinstitutions,andanimaginedworldwithoutanyagencyproblemsorinformationasymmetries(andthereforeaworldinwhichnogovernanceisrequired),includinganydeviationfromrst-bestproductionandexchange,canbecalledatransactioncost.Despitethisbreadth,theconceptoftransactioncostshasachievedwideacceptanceasananalyticaltoolinthetheoreticalliteratureoninstitutions,particu-larlywithintheinstitutions-as-rulesframework.Theusefulnessoftheconceptis Williamsonreferstothisasthediscriminatingalignmenthypothesis.Thus,forWilliamson,Theoverallobjectoftheexerciseessentiallycomesdowntothis:foreachabstractdescriptionofatransaction,identifythemosteconomicalgovernancestructure(Williamson,p.234).Institutions:RulesorEquilibria?17 thatitprovidesameasureofinstitutionalefciency.However,theuseoftrans-actionscoststerminologyriskscloudingtheissueofenforcement.Toillustrate,consideranagencyrelationshipbetweenamanagerandtheworkerswithinarm.Thesaleoftheagentslaborservicesinvolvesafundamentalproblemofexchange:thedecisionofwhethertoworkhardismadebytheagent,butitaffectsthewelfareoftheprincipal.Giventhisfundamentalagencyproblem,differentinstitutionswillgiverisetodifferentpatternsofbehavior.Theexplicitandmeasurabletransactionscostsinsuchasettingmightincludethecostsofhiringamanagertomonitortheworkersandmeasuretheirperformance,aswellasthecostsofdesigninganorgani-zationsoastoenablethismonitoringtooccur,choosingaproductionprocesswhichfacilitatessuchmonitoring,installingsurveillanceequipment,andthelegalcostsofnegotiatingemploymentcontracts,andsuingorringashirker;andsoon.Inaddition,ifintheenditprovestoocostlytomotivatetheworkertoactasshewouldinarst-best(zerotransactionscost)world,thentheresultinginefciencywouldbeanother(implicit)transactioncost.Butwhiletheconceptoftransactionscostscanserveasahandyshorthandtodescribehowwelltheseproblemsaresolved,allofthesecostsultimatelyderivefromtheagencyproblemsandinformationasymmetrieswhichgiverisetothefun-damentalproblemofexchangeinthe(potential)transactionofinterest.Byseparat-ingthecostsofrunningtheeconomicsystemmonitoring,enforcement,andsoonfromthesystemitself,theinstitutions-as-rulesapproachcloudstheissueofpeopleactastheydo,andbecomesapooranalyticalsubstituteforanaccountofhowbehaviorisactuallymotivatedwithinalternativeinstitutionalregimes,noneofwhichwillapproximatethezero-transactions-costideal.Thatis,theproblemofdesigningefcientinstitutionsisnotfundamentallyaproblemofchoosingrulessoastominimizecosts,butaproblemofaligningincentivesinawaywhichgene-ratesthemaximumpossiblebenet,givenafundamentalproblemofexchange.Higherefciency(oralowertransactioncost)isadesiredoutcomeofasuccessfulsolutiontothisproblem,butitisnottheproblemitself,andfocusingontransactionscostsasacatch-allminimandrisksmaskingtheessenceoftheproblem,whichisoneofaligningincentives.3InstitutionsasRules:Applications3.1CommunitiesandNetworksCommunityenforcementreferstoasituationinwhichbehaviorwithinagroupisgovernedbyruleswhichareenforcedbythemembersofthegroupthemselvesratherthanaspecialistthird-partyenforcer.Oneviewholdsthatthesekindsofinformalrulesarebesttakenaspartofaxed,exogenously-givenculturalheritage(Williamson).Otherauthors,however,considerthatinformalrulescontinu-allyadaptandevolve.Forexample,basedonhisstudiesofcattlefarmersinShastacountyandNewEnglandwhalers,RobertEllickson()hypothesizesthatgroups18A.GreifandC.Kingston withinwhichinformation(gossip)circulateseasilyandinformalpowerisbroadlydistributedwilltendtodevelopefcientinformalrules.Ostrom()foundthatmanycommunitiesmanagetodeveloprulestosuccessfullyavertthetragedyofthecommonsinthemanagementofcommon-poolresources,suchassheries,forests,andcommonpasture.Othercommunities,however,donot,andOstromfoundthatsuccessfulrulesweremorelikelytoemergeingroupswithsmallnumbersofdeci-sionmakers,longtimehorizons,andmemberswithsimilarinterests.Ascommunitiesbecomelarger,therefore,bothEllicksonsandOstromsstudiessuggestthatinformalcommunityenforcementislesslikelytobeabletosupportefcientoutcomes.Forexample,astheonlinecommunityoftradersoneBaygrewinthelate1990s,thetrustsustainedbyamultilateralreputationmechanismbasedonuserfeedbackhadtobegraduallysupplementedbyformalrulesdevelopedbyeBaytodiscouragecheating,resolvedisputes,andpreventillegaltrades(Baron20013.2OrganizationsOrganizationsareakintoarticialcommunitiesofindividualsbroughttogetherforaspecicpurposesuchasproduction,politicalactivity,religiousworship,recreation,andsoon.Whilesomeorganizationsmaybeginasinformalgroupswhosememberslaterdecidetodevelopaformalgovernancestructure,othersarecreateddenovobyentrepreneurswithagoalinmind.Assuch,organizationsarebothcohesiveentitieswhichimpactandinteractwiththebroaderworldaroundthem,andgovernancestructureswhichdevelopformalrulestogoverntheinterac-tionsamongtheirmembersandbetweenmembersandoutsiders.Withintheinsti-tutions-as-rulesframework,differentauthorshavefocusedoneachofthesetwoaspectsoforganizations.Someauthors,notablyDouglassNorth,havetreatedorganizationsprimarilyasuniedentitiesthatinteractwiththebroadereconomicandpoliticalsystemwithinwhichtheyareembedded,andinparticular,mayactasplayersofthepoliticalgame,attemptingtoalterbroaderinstitutionalrulesforthebenetoftheirmem-bers.ThisaspectoforganizationswillbediscussedinSect.(Politics).Theotheraspectoforganizationstheirinternalgovernanceisstudiedineconomicsprimarilyintheguiseofthetheoryoftherm.Asiswellknown,themoderntheoryofthermoriginateswithCoases(insightthatorganizationsandmarketsarealternativemodesoforganizingtransac-tions,andtheclaimthatthescopeofactivitycarriedoutwithinorganizationswillthereforebedeterminedsoastominimizetransactionscosts.Toexplainthestruc-tureofanorganization,therefore,weneedtoexplainitsfunction:whatcontractualproblemitefcientlysolves.Butwhywouldefcientorganizationsemerge?Onepossibilityisthatthestructureoforganizationsisaproductofrationaldesign.Iftheorganizationscreatorshaveacorrectunderstandingoftheeffectsofdifferentorganizationalforms,thenitmaybereasonabletoassumethattheywilldesignef-cientorganizations.Institutions:RulesorEquilibria?19 However,analternativeexplanationfortheemergenceofefcientorganizationsisthatevolutionarypressureforcesrmstoselectefcientorganizationalformsbydrivingless-efcientorganizationsoutofbusiness.Alchian()wasanearlyproponentofthisview,anditalsoimplicitlyunderliesWilliamsonsTransactionsCostEconomics,whichassumesthatorganizations(governancestructures)willdevelopsoastoachieveanoptimal(efcient)matchwiththetransactionstheygovern.Theevolutionaryapproachhastheadvantage,notedbybothAlchianandWilliamson,thatitenablesustoassumethatefcientinstitutionswilldevelopevenifthepeopledesigningthemareboundedlyrational.Ifaparameterchange,suchasachangeintechnology,rendersexistinginstitutionsinefcient,thenovertime,byaccidentordesign,somermswilldevelopmoreefcientsetsofrules(gover-nancestructures),andthroughcompetitivepressure,thesenewinstitutionswillgraduallyspread,sothattheinstitutionsgoverningtherelevanttransactionwillevolvetowardoptimality.Thus,theusefulnessoftherational-choiceframeworkdoesnotrestonanassumptionofrationality.Thevalidityofthisapproach,however,restsontheimplicitassumptionthattherearedeeperunderlyinginstitutionsthatleadtotheselectionofoptimal(ef-cient)institutions.Theissueofwhatexactlytheseunderlyinginstitutionsareisfrequentlyleftunexplored,andthustheanalysiscanofferonlyapartialexplanationfortheobservedcongurationofrules.Nevertheless,forthepurposeforwhichitwasdeveloped,namelyexaminingthegovernancestructuresofrmsoperatingincompetitivemarketswithinamoderneconomy,thisapproachworkswellandisanempiricalsuccessstory(Williamson,p.607).Theassumptionthatorganizationsareorganizedefciently(whetherthroughevolutionordesign)alsounderpinsmuchofthemoderntheoryoftherm,inclu-dingtheliteratureonprincipal-agentproblemswithintherm,whichstudieshowmanagementcandesignoptimalincentivesystemstomotivateworkers;theproperty-rightsapproachfollowingHart(),whichpostulatesthattheboundaryoftherm(ownershipofassets)isdeterminedinsuchawayastominimizetheinefciencieswhichresultfromtheinabilitytowritecompletecontracts;andthetheoryofmechanismdesign.Informalrulesandnorms,suchasacorporateculture,mayalsodevelopwithinorganizations,includingrms.Theinternalgovernanceoforganizationstypicallyinvolvesacombinationofbothformalandinformalrules.Forexample,oneapp-roachtoovercomingtheprincipal-agentproblembetweenmanagementandwork-erswithinarmisthroughoptimalwageandbonusstructuresbasedoncontractibleoutputmeasures.However,analternativewaytomotivateworkereffort,giventherepeatednatureoftherelationship,isviathethreatofringaworkercaughtshirking(BowlesandGintis).Whiletheformalcontract,accordingtowhich NelsonandWinter()builtanevolutionarytheoryofthermbasedontheevolutionofroutinessequencesofactionwhichcoordinatetheactivitiesofmanyindividualsratherthanrules.Routinesevolveassuccessfulrmsexpandandtheirroutinesareimitatedperhapsimperfectlybyothers,creatingatendencytowardstheadoptionofefcientroutines(althoughpossiblywithconsiderableinertia).20A.GreifandC.Kingston theworkerispaidawageforshowinguptowork,regardlessofhereffortisenforceableinthecourts,theworkerseffortlevelisnotcontractible,andsotheemploymentrelationshipisgovernedbybothformalandinformalrules:higheffortisenforcedinformallythroughthreatofnon-renewaloftheformalcontract.3.3Politics,InformalRules,andInstitutionalChangeThestate,ofcourse,isthemostimportantsourceofformalrules,includinglaws,constitutionalrulesanddecreespassedbyrepresentativebodies,votedonbycitizens,orproclaimedbykings.Standardneoclassicaleconomicsassumestheexistenceofawell-functioningstate,andstateactivitiessuchastaxation,regulation,andtheprovisionofpublicgoodsaretreatedaswell-functioningpolicyinstrumentsinthehandsofabenevolentpolicymaker.Whilethistreatmentofthestateisusefulforsomepurposes,itiswoefullyinadequateforothers.Itmakesimprobableassumptionsaboutthestatesabilitytoobtainandprocesstheinformationneededtoarriveatanoptimalconclusion(Hayek1945),anditobscuresthefactthatpolicydecisionsaregenerallytheresultofbargainingandnegotiationamongorganizationsandindivi-dualswithdivergentinterests,andthatimplementingthesedecisionsinvolvesmoti-vatingandcoordinatingtheorgansofthestate,suchasregulatoryagencies,courts,andthepolice.Akeyfunctionofthestate,takenasagiveninneoclassicaleconomics,istoprovidesecurityofpropertyrightsandcontractenforcement.Intheabsenceofastate(anarchy),individualsmustinvestresourcesintheprivateproductionofsecuritybyacquiringacapacityforviolence(Skaperdas2006).Thewell-knownHobbesianjusti-cationforthecreationofthestateisthatthepresenceofahigherauthorityenablespeopletoreplacethecostlyandinefcientspontaneousorderofanarchywithasetofrulesdesignedtoimproveoverallwelfare.InYoramBarzelsHobbesiantheoryoftheoriginsofthestate(Barzelindividualsbegininastateofnaturewithoutinstitutions,andtheynditintheirintereststocreateastate,asamonopolistofviolence,toprovideorder.However,theywishtoefcientlylimitthestatesscopeofactivity.Thisraisesthequestionofwhythestate(whichBarzeltreatsasasingleactor)wouldobeytherulesthatitssubjectscreateforit,ratherthanusingitscapacityforviolencetoexpropriatethoseunderitsruleorexpandthescopeofitsactivitybeyondthatwhichisoptimal.Barzelnotesthisdanger,andpostulatesbeforethepeoplecreateastate,theywillalsocreatecollective-actionmechanismsthatconstrainthestatesactionsbyenablingthemtooverthrowthestateifitbecomespredatory.However,inkeepingwiththeinstitu-tions-as-rulesapproach,Barzeltreatstheenforcementofthesecollectiveactionmechanismsasexogenous.Asaresult,theenforcementproblem(keepingthestate Althoughthesocialarrangementsusedtoenforcedecisionsbycollective-actionmechanismsseemtobeofutmostimportance,thereislittlethatI,asaneconomist,cansayaboutmostofthem.Isimplyassumethatsucharrangementsexistandareputintouse(Barzel,p.119).Institutions:RulesorEquilibria?21 honest)ismerelypushedbackonelevel;ultimately,theenforcementoftheformalrulesistakenasexogenous.Theproblemofempoweringthestatetocreateorderwhileconstrainingitfrompredationisoffundamentalimportance.Djankovetal.()postulatethattheinstitutionaldesignofthestateinvolvesafundamentaltradeoffbetweendisor-deranddictatorship:creatingamorepowerfulstatehelpstoreducedisorderandtherisksofprivateexpropriation,butatthecostofincreasingthecostsofdictator-ship,corruptionandexpropriationbythestate.Eachsocietyhasasetoffeasiblecombinationsofdictatorshipanddisorder(aninstitutionalpossibilitiesfrontier),whichdependsonavarietyofsocietalcharacteristicsincludingtechnology,culture,education,socialcapital,ethnicheterogeneity,history,factorendowmentsandthephysicalenvironment.InDjankovetal.sbasicmodel,societieschooseanoptimalpoliticalsystem(thatis,onewhichminimizesthesumofthecostsduetoprivateandpublicexpropriation)subjecttotheconstraintofitsinstitutionalpossibilityHowever,thereareavarietyofpotentialimpedimentstotheselectionofefcientpoliticalrules.Djankovetal.arguethatcountrieswhichareformercoloniesmighthaveinefcientrulesiftherulesweretransplantedorimposedbytheirformalcolonialmastersratherthanarisingindigenously.LaPortaetal.()ndthatcountrieslegaloriginsaffecteconomicoutcomes.Thecivillawsystem,theyarguefavorsagreaterdegreeofstatecontrolandregulation,whereasthecommonlawsys-temreliesmoreonmarket-supportingregulationandprecedent-settingprivatelitigation.Manyauthorsemphasizethatdistributionalconictcanleadtotheselectionofinefcientrules.Forexample,Libecap(1989)exploresthedevelopmentofthepropertyrightsrulesthatgoverntheuseofavarietyofresourcessuchassheries,mineralrights(mining),andtheuseofpublicland.Differentrulesentaildifferentdistributionalconsequences,andindividualsandgroupsthereforeengageinbargain-ing,lobbying,andpoliticalactiontotrytoaltertherulesfortheirownbenet.AsinOstromsschema,thisrule-changingactivity(contracting)isitselfagamegovernedbyahigherlevelofpoliticalrules,andthesehigher-levelrules,togetherwiththeacti-vitiesandperceptionsoftheactorsthereforeshapethedirectionofinstitutionalchangeofthelower-level(propertyrights)rules.Acemoglu()andAcemogluandRobinson(2006)emphasizetheimpor-tanceofcommitmentproblemsasanimpedimenttotheselectionofefcientrules.Politicalincumbentsmightbewillingtomakeconcessionstodisenfranchisedgroupsinordertoavertacostlyorviolentrevolution,butiftheycannotcrediblycommitthemselvestohonortheircommitmentstoreformafterthemomentofcrisisispassed,thenwhenevergroupshavetheopportunity,theywillseizepowerandcraftrulestobenetthemselveswithoutregardfortheothergroups. See,however,Hadeld(),whocastsdoubtontheimportanceofthecivil-law/common-lawdistinction,andprovidesaricherandmorerenedalternativesetofkeyparametersfortheclassicationoflegalregimes.22A.GreifandC.Kingston Evenifasocietydoesinitiallyselectruleswhichareefcientinastaticsense,theserulesmayultimatelyturnouttobesuboptimalinadynamicsense.Forexample,EngermanandSokoloff()arguethatthesoilandclimateinEuropesSouthAmericanandCaribbeancoloniesweresuitablefortheproductionofcashcrops,suchassugar,thatcouldbeefcientlyproducedonlargeslaveplantations,resultinginhighlyunequaldistributionsofwealth,income,andhumancapital,whichinturnenabledtheelitestoestablishlegalandpoliticalinstitutionsthatpromotedtheirinterests.IntheNorthAmericancolonies,incontrast,theinitialfactorendowmentsweremorefavorabletotheproductionofcropsandlivestockthatcouldbeefcientlyproducedinsmallfamilyfarms.Thisledtothedevelopmentofmoreegalitariananddemocraticpoliticalinstitutions,higherlevelsofpublicgoodsprovision(suchasprimaryschooling),andgreaterlevelsofsocialmobility.Acemogluetal.()tellarelatedstory,butwiththefocusonthediseaseenvironmentandindigenouspopulationdensityratherthansoilandclimateasthekeyexogenousvariablesexplainingtheinitialdevelopmentofstateinstitutions.InplaceswhereEuropeansfoundsettlementdifcult,theycreatedextractivestatesaimedattransferringresourcestothemothercountry.InareasmoreconducivetoEuropeansettlement,theyfounditmoreprotabletobuildinstitutionsaimedatpro-tectingprivatepropertyandencouraginginvestment.Theseinstitutionspersistedevenafterindependence,andledtoareversaloffortuneinthenineteenthcentury,becauseregionsthathadpreviouslybeenpoorinheritedinstitutionsthatlaterenabledthesocietiestoindustrialize.Theseargumentsgivehistoryaroleinexplainingthescopeandfunctioningofthestate.Institutionsdevelopedasanefcientresponsetocircumstancesinonetimeperiodmaypersisteveniftheylaterbecomeinefcient.Butwhydoinstitu-tionspersist?Again,thebasicanswerwithintheinstitutions-as-rulesapproachisduetoNorth(),whodevelopedatheoryofinstitutionalchangethatcombinesdeliberatechangesinformalruleswithevolutionarychangeininformalrules.InNorthstheory,giventhecurrentstructureofformalandinformalrules,entrepre-neursformorganizationstotakeadvantageofperceivedopportunities.Overtime,astheyacquireskillsandknowledge,theymaynditworthwhiletoattempttochangethestructureofformalrules.Whenchangesinformalrulesoccur,thentheinformalruleswhichhadgraduallyevolvedasextensionsofpreviousformalrules(p.91)adjustinresponse,andtheendresulttendstobearestructuringoftheoverallconstraintsinbothdirectionstoproduceanewequilibriumthatisfarlessrevolutionary(North,p.91).Thus,Northarguesthatbecauseofthepersistenceoforganizationsandinformalrules,overallinstitutionalchangeisoverwhelminglyincremental(Northp.89),andthatinstitutionalchangeisapath-dependentprocess:theconsequenceofsmalleventsandchancecircumstancescandeterminesolutionsthat,oncetheyprevail,leadonetoaparticularpath(North1990,p.94).Currentinstitutionsprovideincentivestocreateparticularkindsoforganizationsandtoinvestinparticularkindsofskillsandknowledge.Theyalsoaffectthedistributionofwealthandpoli-ticalpower,thepreferencesoftheactors,andthestockofphysicalandhumancapital.AlloftheseendogenousparameterchangesinturnaffectthecostsandbenetsofInstitutions:RulesorEquilibria?23 alternativeinstitutions,peoplesperceptionsofnewpossibilities,andtheirabilitytobringaboutorstieinstitutionalchange.Inalltheseways,pastinstitutionscaninuencethedirectionofinstitutionalchange(Libecap;Pierson;NorthBuildingonNorthswork,agrowingrecentliteratureconsidersprocessesofinstitutionalchangethatexploretheinteractionbetweenformalandinformalrules.InRoland()stheory,informalrules(slow-movinginstitutions)arecon-stantlyevolving,andifthesechangesbecomeincompatiblewithexistingformalrules,thenpressureforchangebuildsup,leadingtoperiodicabruptandsubstantialchangesinformalrules(fast-movinginstitutions).BrousseauandRaynaud(2008buildatheoryinwhichnewrulesbeginasinformal,localandexibleorders,whichcompeteforvoluntaryadherents.Successfulrulesspread,andastheyspread,theybecomeincreasinglyglobalandmandatoryandhardenintorigidformalrules.Aldashevetal.()showthatchangesinformalrulescanalteroutsideoptionsandthereforebargainingpowerwithininformalrelationships,andtherebyshiftcustomaryinformalrulesinthedirectionoftheformallaw,evenifitisneverexplicitlyused.Onedifcultywhicharisesinthinkingaboutinstitutionalchangeinthiswayasaninteractionbetweenformalandinformalrulesisthatthenatureoftheinformalrulesisoftenleftrathervague,andhowtheyinteractwithformalrulesforexample,whichruleisfollowedwhenthetwokindsofrulesconictremainsunclear.Asnotedabove,theinstitutions-as-rulesapproachtreatsthequestionofhowrulesareenforced,andthereforewhytheyarefollowed(ornotfollowed),asaseparateissuefromtheircontent.Thusbydenition,ifbehaviordoesnotconformtoformalrules,bydefaultitisattributedtoandassumedtobegovernedbyunobservedinformalrules.Yet,sinceinformalrulesaregenerallyimplicit,itishardtoobservewhattheseinformalrulesare,whetherinfacttheyareindeedbeingfollo-wed(andifso,why),andwhatkindsofbehaviortheyareaffecting,andinwhatway.Attributingunexplainedbehaviortoinformalrulesthereforeamountstoaleapoffaiththatinvokesamysteriousandscienticallyuntestableexplanationfortheobservedbehavior.Theproblemiscompoundedbythefactthattheterminformalruleshasbeenusedtodescribeseveralquitedistinctphenomena.Someauthorstreatinformalrulesasinternalizedethicalcodesofconductwhicharedirectlyreectedinplayerspreferences(e.g.,Ostrom).Forothers,informalrulesareruleswhicharenotwrittendown,orwhicharenotenforcedbythestate.Stillothersidentifyinformalrulesasself-enforcingcodesofconduct,sharedculturalfocalpoints,orassocialnormsenforcedwithinacommunityusingamultilateralreputationmechanismorasallofthesethings,astheoccasiondemands.Forsome(e.g.Williamsoninformalinstitutionschangeonlyoveraperiodofcenturiesormillennia,sotheymaysafelybetakenasexogenousandxed,whileothers,suchasRoland,holdthatgradualchangesininformalrulesareoftenanimportantpartofthestoryofinsti-tutionalchange.Ultimately,therefore,theinstitutions-as-rulesapproachislimitedinitsabilitytoexplaininstitutionalchangebecauseakeyelementinhibitingandshapingthe24A.GreifandC.Kingston directionofinstitutionalchange,informalrules,originatesoutsidetheanalyticalframework.Forexample,Ostrom(,p.138)notesthatmanywrittenstatementshavetheformofaruledonotaffectbehavior.Suchstatementsareconsideredrules-in-formratherthanrules-in-use.Yet,becauseshetreatstheenforcementofrulesseparatelyfromtheircontent,anyexplanationofwhatmakessomerulesrules-in-usewhileothersrulesareignoredisoutsideherframework.Shenotesthatinsettingswhereaheavyinvestmentisnotmadeinmonitoringtheongoingactionsofparticipantsconsiderabledifferencebetweenpredicatedandactualbehaviorcanoccur,(p.21),butachievingthismonitoringandenforcementistreatedsimplyasacost;theincentivesofthemonitorsarenotexamined.4Self-EnforcingInstitutions,orInstitutions-as-Equilibria:ConceptualIssuesThecoreideaintheinstitutions-as-equilibriaapproachisthatitisultimatelythebehaviorandtheexpectedbehaviorofothersratherthanprescriptiverulesofbehaviorthatinducepeopletobehave(ornottobehave)inaparticularway.Theaggregatedexpectedbehaviorofalltheindividualsinsociety,whichisbeyondanyoneindivi-dualscontrol,constitutesandcreatesastructurethatinuenceseachindividualsbehavior.Asocialsituationisinstitutionalizedwhenthisstructuremotivateseachindividualtofollowaregularityofbehaviorinthatsocialsituationandtoactinamannercontributingtotheperpetuationofthatstructure.Thefocusonregularitiesofbehaviorandthemotivationtofollowthemrespondstotheobservationthatthesefactors,ratherthanrules,arethedirectcauseofdistinctwelfare-relatedoutcomes.Thecorruptionplaguingmanypoliticalsystemsintheworldisnotcausedbyanabsenceofrulesprescribingpreventivemeasures.Itisduetoparticularregularitiesofbehavior.Focusingonmotivationhasthekeyadvantageofavoidingtheconceptualdif-cultiesthatcomewithtreatinginstitutionsasrules.Forexample,thelegalspeedlimitonhighwaysinMassachusettsis65mph,butthislimitiswidelyignored.Thisisnottosaythattherearenorules,however.Policeofcersdosometimespullovercarstravelingat85mph,buttheyneverpullovercarstravelingat68mph.Whataccounts Thisideabuildsontheconventionsliterature(e.g.,Sugden).SeealsoSchotter(Calvert(),Aoki(),Dixit(),KingstonandCaballero()andGreif(Aregularityofsocialbehaviordoesnotimplyuniformityofbehaviorasitisacharacteristicofaggregatesofindividualsandnotofeachindividual.Furthermore,socialbehaviorisusuallyconditionalonsocialrolesanddoesnotnecessarilyimplythesamebehaviorbyindividualswiththesamerole.Thebehavioralregularityofmalesproposetoafemaleandonlywhentheycansupportafamily,forexample,capturesgenderrolesandimpliesthatsomemaleswillnevermarryandtheagesofthosewhodo,willvary.Similarly,regularityofbehaviorisnotnecessarilyfrequentbehavior.TheprocessofimpeachingaUSpresidentisregularizedalthoughrarelyInstitutions:RulesorEquilibria?25 forthedifferencebetweenthebehaviorspeciedbytheformalruleandthebeha-vioractuallyobserved?Fromtheinstitutions-as-rulesperspective,thestandardanswerwouldbethatthepoliceandmotoristsmustbefollowinganinformalruleforexample,thatthetruespeedlimitis75mph.Butthisinvokesanexogenousandad-hocexplanationforpreciselywhatwewouldmostliketoexplain.Focusingonmotivationcomplicatestheanalysis,however.Onereasonisthatregularitiesofbehaviorareoftencausedbytheneteffectofmultiple,andpossiblyconicting,motivatingfactors.Thefearoflegalsanctionsmightmotivateateenagedrivertoslowdown,butsocialpressurefromhispeersmighthavetheoppositeeffect.Theevolvinginstitutions-as-equilibriaapproachhasnotyetconvergedonanagreeddenitionofinstitutions.Ontheonehand,Calvert(),forexample,literallyequatesinstitutionswithgametheoreticequilibria.Thereis,strictlyspea-king,noseparateanimalthatwecanidentifyasaninstitution.Thereisonlyrationalbehavior,conditionedonexpectationsaboutthebehaviorandreactionsofothersInstitutionisjustanamewegivetocertainpartsofcertainkindsofequilibria(pp.2223).Thepremiseofthisdenition,however,istoorestrictive.Gametheoryprovideslittleguidanceforidentifyinginstitutionsorstudyingtheirdynamics.Greif,Chaps.2and5)denesaninstitutionasasystemofinstitutionalelements,particularlybeliefs,norms,andexpectationsthatgeneratearegularityofbehaviorinasocialsituation.Theseinstitutionalelementsareexogenoustoeachdecision-makerwhosebehaviortheyinuence,butendogenoustothesystemasawhole.Thesocialruleswhichemergecorrespondtobehaviorwhichisendogenouslymotivatedconstrained,enabled,andguidedbyself-enforcingbeliefs,normsandexpectations.Inaddition,foraninstitutiontobeperpetuated,itsconstituentele-mentsmustbe(1)conrmed(notrefutedoreroded)byobservedoutcomes(2)rein-forcedbythoseoutcomes(inthesensethatitsabilitytobeself-enforcingdoesnotdeclineovertime)and(3)inter-temporallyregeneratedbybeingtransmittedtonewcomers.4.1Self-EnforcingExpectationsandMotivationAnempirically-orientedanalysisrelyingontheinstitutions-as-equilibriaapproachfocusesprimarilyonmotivationprovidedbyself-enforcingexpectations(behav-ioralbeliefs).Suchananalysisusuallybeginsbyidentifyingtheessentialphysi-cal,technologicalandsocialattributesnecessaryforthesituationtobeofinterest.Inthecaseofregularitiesofbehavioramongdrivers,forexample,essentialattri-butesincludethattheremanydriverswhohavepropertyrights(oruserrights)incars,canbenetfromdrivingcomparedtoalternativemodesoftransportation,canobserveothercars,andprefertoavoidaccidents.Withoutanyofthesefeatures,consideringdrivingbehaviorismeaningless.Similarly,theanalysiswouldbetoogeneralwithoutmorenarrowlydelineatingtheregularitiesofbehaviorweareinterestedin:isitthedirectionoftrafc,priority-rulesatintersections,speedingorpassing?26A.GreifandC.Kingston Byfocusingonasituationsessentialattributes,weinitiallysetasidethosepotentiallyrelevantsocialconstructsthatweinitiallywishtotreatasexogenoustotheanalysis.Inthecaseofdriving,thesemightincludesuchconstructsasdriverslicenses,socializationtodrivecarefully,oraHighwayPatrolAgencywiththecapa-citytoimposelegalsanctions.Initiallyignoringsuchpotentiallyimportantcon-structsisnotastatementabouttheirirrelevancebutameanstoanalyticallyexaminewhethertheyarerelevant,whytheyarerelevant,andtowhateffect.Thenextstepintheanalysisistofocusonthesetofself-enforcingexpectationsandtheimpliedbehaviorthatcanprevailinthissituation,bymodelingthesituationasagame(specifyingthesetofplayers,theirpossibleactions,theorderofmoves,information,andpayoffs)andndingequilibria.Byself-enforcingexpectationswemeanthatifthedecision-makerssharetheexpectationthatotherswillgenerallyfollowtheequilibriumbehavior,theneachofthemwillbemotivatedtofollowitaswell(theNashcriterion).Fromeachdecision-makersperspective,theothersexpectedbehaviorconstitutesthestructuremotivatinghertoconformtothebeha-viorexpectedofher.Butbyconforming,shecontributestomotivatingotherstoconformtoo.Thus,thestructureisself-perpetuating,andalthoughitisbeyondthecontrolofeachdecisionmaker,itisendogenoustoallofthemtakentogether.Notethattheself-enforcingrequirementincludesexpectationsabouthowotherswillbehaveinsituationsthatwouldnottranspireinequilibrium.Forexample,ifaplayerdoesnotstealbecauseofafearofpunishment,theoff-the-pathexpectationofpunishmentmustbecredible(thisthesub-gameperfectionrequirement).Havingfoundequilibriaintheminimalgame,wecannextexaminehowvarioussocialconstructscanchangethesetofself-enforcingexpectationsbychangingtheexpectedresponsesbyotherplayerstoparticularactions.Whentheseexpectationsarecredible,thecostsandbenetsassociatedwithactionsintheminimalgamearechanged,andthesetofpotentiallyself-enforcingbehaviorsmaybeenlarged.Forexample,thecreationofagroupcancreaterestrictionsonentrytothesituation(whotheparticipantsare)andchangethepatternofrelations(e.g.,repeatedinter-actionsamongthesameindividuals).Otherkindsofsocialconstructsmightaltertheinformationstructure,orintroduceanewactorwiththeabilitytopunishorrewardplayers(e.g.,ajudge).Theintroductionofnewsocialconstructscanchangepeoplesexpectations(andthereforeincentivesandbehavior)inmanyways.Sanctionscanbecoercive(suchasviolenceorimprisonment),social(suchasostracism),oreconomic.Guiltandthefearofexpectedpunishmentintheafter-lifeareothermeanstolinkpastactionstofuturerewards.Theinstitutions-as-equilibriaapproachfocusesonhowsuchexpec-tationsareformed,why,andtowhateffect.Notethatthisinvolvesmuchmorethanjusttheintroductionofnewrules.Inordertoshiftpeoplesexpectations,cogni-tivecategories(e.g.,honesty,cheating)needtobecoordinateduponsothatallplayerssharecoordinatedexpectationsaboutpunishment.Ifthedesiredbehavioristobeself-enforcinginthemodied,extendedgamethatincludesthenewinterac-tions,thenthepunishmentshouldbesufcientlycostlytomakedeterrenceeffective.Thosewhoaretoretaliatemusthavetheinformationaboutwhoandwhentopunish,whichpotentiallyincludesmotivatingthosewhoknowaboutthetransgressiontoInstitutions:RulesorEquilibria?27 informothers.Peoplemustalsobemotivatedtopunish,astheexpectationthatpunishmentwillbeinictedhastobecredible.Furthermore,theyhavetohavethephysicalcapacitytopunishandthosewhoaretobepunishedshouldnotbeabletoevadepunishment.4.2RulesandOrganizationsintheInstitutions-as-EquilibriaIntheinstitutions-as-rulesapproach,rulesareinstitutionsandinstitutionsarerules.Rulesprescribebehavior.Intheinstitutions-as-equilibriaapproach,theroleofrules,likethatofothersocialconstructs,istocoordinatebehavior.Becausetherearemultiplepotentiallyself-enforcingexpectationsinagivensituation,coordinationmechanisms,includingrules,playanessentialroleingeneratingregularitiesofbehaviorandsocialorder.Rulesfulllthiscoordinatingrolebyspecifyingpatternsofexpectedbehavior,andalsobydeningthecognitivecategoriessigns,symbols,andconceptsonwhichpeopleconditiontheirbehavior.Actionshavetobegivenmeaningsbecause,forexample,cheatingisnotnaturallydened,butitmustbedenedbeforeitcanbediscouraged.Aroadsigninstructingadrivertoyieldatapedestriancrossinghasmeaning,andmotivatesbehavior,onlybecauseitisacom-ponentofasystem(rulesoftheroad)thatmotivatesbehaviorbasedonroadThebehaviorthatpeoplecanbemotivatedtofollowdependsonthesecogni-tivecategoriesandontherulesabilitytocoordinateexpectationsbasedonthesecategories.Focusingonmotivationexposesthelimitsontherealitiesthathumanscanuserulestoconstruct.Inorderforaruletomatter,thebehaviormustbeself-enforcinganditmustbeconditionedonobservableaspectsofthesituation.Ifdriverscannotobserveapedestriansage,theycannotconditiontheirbehavioronit.Anditmustbesufcientlycostlytocircumventthecategories.Forexample,arulewhichconditionsbehaviorongendermaynotbeself-enforcingifmalescaneasilypretendtobefemalesandviceversa.Ofcourse,thebehavioralexpectationsandcognitivecategorieswhichpeopleactuallyusetocoordinatetheirbehaviormaybequitedifferentfromthosespeciedbyformalrules.Nevertheless,weobservethatexplicitrulesareoftenforma-lizedanddisseminatedinacentralizedmanner.Fromtheinstitutions-as-equilibriaperspective,thecreationofsuchformalrulescanbeinterpretedasanattemptachieveacoordinatedshiftofmanypeoplesexpectations,whileconvincingtheagentsthattheseexpectationsareindeedwidelyshared.Thismechanismcanalsobeused,ofcourse,toservetheinterestsofthepoliticallypowerfulthosewiththepowertochangeformalrules.Butifthenewrulesdonotspecifyaself-enforcingpatternofbehavior,theymaynothavetheirdesiredeffect.Organizations,too,aresocialconstructsthatchangethesetofself-enforcingexpectationsamongtheagentsintheoriginalinteraction.Formalorganizations,suchasparliamentsandrms,andinformalorganizationssuchascommunitiesand28A.GreifandC.Kingston businessnetworks,haveadualrolebothasinstitutionsthatgoverntheirmembersbehavior,andasinstitutionalelementswithinthebroaderinstitutionsofsociety.Withinthegroup,anorganizationcanchangetherelevantrulesofthegame,suchasinformation,actions,andpayoffssets,andcanthereforeincreasethecredibilityandseverityofsanctions,specifyrules,andcreatesharedknowledge.Organizationsmayalsoplayaroleinattemptingtoshapethepreferencesofcommunitymembers,particularlychildren,throughaprocessofsocialization.Anorganizationanditsmembersalsointeract,individuallyandasagroup,withtheoutsideworld,andthebeliefs,normsandexpectationsthatgoverntheinternalinteractionsbetweenthemembersoftheorganizationwilloftendifferfromthosegoverningtheirinteractionswithoutsiders.Apoliceforce,forexample,hasinternalstructuresandrulestogovernitsmembersbehavior,butitalsoactsasanorgani-zationforenforcingotherrulessetbythegovernmentofthesocietyofwhichitisapart.Therelianceonorganizationsisfundamentallyduetothefactthatorganiza-tionshavecapabilitiesthataremorethanthesumoftheindividualcapabilitiesoftheirmembers,duetotheirabilitytocoordinatetheirmembersactivities,econo-miesofscaleandscopeintheireffortstochangetherulesofthegame,andduetotheorganizationslongertimehorizonandmemory.5InstitutionsasEquilibria:Applications5.1MarketsandNetworksTheabilitytoengageinvoluntaryexchangeencouragesproduction,specialization,andinnovation,andisakeyprerequisiteforeconomicefciency.However,inallbutthesimplestmarketexchanges,enforcementproblemsariseduetothefunda-mentalproblemofexchange(Greif).Forexample,inlabormarketandcreditmarkettransactions,thereisanunavoidableseparationbetweenthequidandthequo,andatleastonepartythereforemayhaveanopportunitytocheattheother:aborrowermaychoosenottorepayaloan,oranemployeemaychoosenottoworkhard.Marketscanfunctiononlywhenthisfundamentalproblemofexchangeisovercome.Neoclassicalmicroeconomicstendstoeitherassumeawayenforcementpro-blems,ortotakethepresenceofwell-functioningmarket-supportinginstitutionsasgiven.Theinstitutions-as-rulesapproachisanimprovement,inthatitconsidershowmarketexchangemaybesupportedbyinstitutions(rules)thatpunishdefec-tion,suchasalegalsystem,orinformalcodesofconduct.Forsomepurposesthisisadequate.However,theserulesthemselvesultimatelyrequireenforcement.Foraconvincingaccountoftheinstitutionalfoundationsofmarkets,therefore,weneedtoconsidertheenforcementnotjustofthemarkettransactionsthemselves,butoftheruleswhichgovernthosetransactions.Sayingthatthereisanormagainstcheating,forexample,isinsufcient.ItiscriticaltostudyhowthenormissustainedaspartofInstitutions:RulesorEquilibria?29 aself-enforcingequilibriumoutcomeofagameinwhichtheenforcementofthenormresultsfromthebehavior,andexpectedbehavior,oftheplayers.Thesameistrueifenforcementiscarriedoutbyformalorinformalorganizations,suchasacourt,acreditbureau,oracommunity.Insituationswhereformalinstitutionsdonotfunctionwell,economicagentsmayrelyheavilyoninformalenforcement.McMillanandWoodruff(),forexample,foundthatinVietnam,rmsscrutinizeprospectivetradingpartnerscare-fully,andrelyoninformalprivateorderinstitutions,includingbothbilateralenforcement(ceasingtodobusinesswitharmthatcheats)andmultilateralcomm-unityenforcement(sharinginformationaboutcheaters).However,thesemechan-ismsareapoorsubstituteforwell-functioningformalenforcementmechanisms.McMillanandWoodruffdonotinvestigatehowthebehaviorwhichsustainstheseprivateorderinstitutionsismadeself-enforcing:whydopeopleshareinformationandpunishcheaters,giventhatdoingsoiscostly?Kandori()usesagame-theoreticmodeltoshowthatamongacommunityofplayerswhoarerandomlymatchedintopairseachperiodtoplayaprisonersdilemma,amultilateralcommunityenforcementmechanismcansupportcoopera-tioniftheplayerscanobservealabelwhichindicates(roughlyspeaking)whethertheircurrenttradingpartnerisacheat,andwhichishonestlyupdatedthroughsomeexogenousprocess.Severalpapersstudyhowthiskindofreputationalinfor-mationmightbesharedwithinacommunity.Gazzale()showsthatplayersmayhaveanincentivetogossipbecauseareputationforgossipingcandetertheirfuturetradingpartnersfromcheating.Greif()showshowinfor-mationtransmittedincorrespondenceamongacommercialandsocialnetworkofmedievaltraders(theMaghribitraders)supportedareputationmechanismthatsuccessfullydissuadedcheating.Merchantswhocheatedcouldexpectthattheiractionswouldbewidelyreportedwithinthenetwork.Sincemerchantswhowereostracizedfromthenetworkforcheatinghadnofurtherreputationtolose,theywouldbeexpectedto(rationally)cheatinanyfuturetransactions;andtherefore,eachmerchantinthenetworkwasmotivatedtopunishcheatersbytheexpectationthatotherswouldalsodoso,sothepunishmentwasself-enforcing.Notethatthisapproachdirectsattentionawayfromthecontentoftherulesaboutcheatingtothenetworksandinformationowsthatenabletheexpectationthatotherplayerswillpunishcheatstobesustainedaspartofaself-enforcingequi-librium.Whilethepresenceoftheseinformation-sharingstructures(networksandcommunities)themselvescanbetakenasexogenousintheshortrun,iftheinformalpunishmentmechanismssustainedbythecommunityaretosurviveasinstitutions,themaintenanceofsuchnetworksmustalsoultimatelybemadeendogenoustotheanalysis.Inmanycases,suchastheMaghribitradersstudiedbyGreif,thestructureofthenetworkisinlargepartanoutcomeofanhistoricalprocess.However,evennetworksthatarebequeathedbyhistoryneedtobemaintained.Onewaytostudytheoriginsandstabilityofsuchnetworksistoconsidergroupmembersincentivestoretaintheirafliationexpost,bysubmittingtopunishmentratherthanattemptingtoevadeit(Greif).Anotherapproachistoconsiderthenetworksthemselvesasanoutcomeofapriorgameinwhichplayers(individuals,rms,orcountries,for30A.GreifandC.Kingston example)deliberatelyformlinkswithotherplayers(friendships,supplylinks,ormilitaryalliances,forexample)(Fafchamps;Jackson).Ingeneral,itisnotnecessarilythecasethatthenetworksthatemergethroughsuchaprocesswillbeefcientfromthepointofviewofsocietyoverall,becauseindividualschoos-ingtobuildlinksdonottakeintoaccounttheexternaleffectsofthoselinksonotherplayers.Greif()emphasizesthatwhenthegroupisanoutcomeofahistoricalprocess,theremaynotbeamechanismtocoordinateinclusionofnewmembers.Inefcientsizeisthelikelyoutcome.Evenifformalenforcementmechanismsareavailable,theymaynotbeemployedinequilibrium.Kranton()studiesamodelinwhichagentschoosebetweentradingwithinaninformalnetworkorinananonymousmarketinwhichagencyproblemsareabsentforexample,becausethereisawell-functioningformalsystemtogovernmarketexchange.Thevalueofmarketinteractiondependsonthefractionofplayerswhochoosetobuyandsellwithinthemarket.Therefore,twoequilibriaarise:ifeveryonemakesuseoftheirinformalrelationshipstoobtaingoods,thenthemarketisthin,thesearchcostsofndingatradingpartnerinthemarketarehigh,andeachindividualhasanincentivetousehernetworkratherthanthemarkettoobtaingoods.However,ifinsteadmanypeoplechoosethemarket,thenndingatradingpartnerinthemarketbecomesrelativelyeasier,andtheinformalrelationshipsbreakdownasplayersoutsideoptionimproves.Therefore,eitherpatternofbehavioramarketinwhichpeoplecarryoutephemeral,anony-moustransactions,orapatternoftradingwithinlong-lived,trustinginformalrelationshipscanemergeasaninstitutioncorrespondingtoanequilibriumofthegame.Ifthesocietybeginsinoneequilibrium,intheabsenceofexogenousshocks,orsomecoordinatingmechanismtoengineeracoordinatedshiftinbehavior,itmayremainstuckinthatequilibriumevenifthealternativeequilibriumwouldbemoreefcient.Thus,startingpointsmatter,andhistoryplaysaroleinequilibriumselection.Krantonsanalysistakesthemarketasgiven,butthepresenceoflegalcontractenforcementmayitselfbetreatedasendogenous.Greif(19942006)hasarguedthatinmedievalEurope,theGenoesesocietycharacterizedbyindividualisticculturalbeliefsandinterest-basedcommunitiesexperiencedahigherdemandforlegalcon-tractenforcementthanthecollectivistculturalbeliefsandkin-basedcommunityoftheMaghribitraders.Asaresult,theGenoesedevelopedformalinstitutionsinclud-ingcodiedcontractlaws,double-entrybook-keeping,familyrms,billsoflading,andotherantecedentsofmodernbusinesspractices.5.2OrganizationsAsthesizeofacommunitygrows,relyingsolelyoninformalgovernancemaytendtobecomeproblematicasplayersabilitytoobserveeachothersactions,andtoshareinformationabouttransgressions,diminishes.Asaresult,thereisatendencytoevolvefrominformaltomoreformalmodesofgovernance.Institutions:RulesorEquilibria?31 Forexample,atthemedievalChampagneFairs,largenumbersofmerchantsfromalloverEuropecongregatedtotrade.Merchantsfromdifferentlocalitiesenteredintocontracts,includingcontractsforfuturedelivery,thatrequiredenfor-cementovertime(Verlinden;Milgrometal.).Therewasnostatetoenforcethesecontracts,andthelargenumberofmerchantsaswellastheirgeo-graphicdispersionmadeaninformalreputationmechanisminfeasible.Greif(arguesthatimpersonalexchangewassupportedbyacommunityresponsibilitysys-tem.Traderswerenotatomizedindividuals,butbelongedtopre-existingcommu-nitieswithdistinctidentitiesandstronginternalgovernancemechanisms.Althoughparticulartradersfromeachcommunitymayhavedealtwithmerchantsfromano-thercommunityonlyinfrequently,eachcommunitycontainedmanymerchants,sotherewasanongoingtradingrelationshipbetweenthecommunities,takenasawhole.Merchantsfromdifferentcommunitieswereabletotrusteachother,eveninone-shottransactions,byleveragingtheinter-communitytrustwhichsustainedtheseinteractions.Ifamemberofonecommunitycheatedsomeonefromanothercommunity,thecommunityasawholewaspunishedforthetransgression,andthecommunitycouldthenuseitsowninternalenforcementinstitutionstopunishtheindividualwhohadcheated.Thissystemwasself-enforcing.Tradershadanincentivetolearnaboutthecommunityidentitiesoftheirtradingpartners,andtoestablishtheirownidentitiessothattheycouldbetrusted.Thecommunitieshadanincentivetoprotecttherightsofforeigntraders,andtopunishtheirmembersforcheatingoutsiders,soastosafe-guardthevaluableinter-communitytrade.Communitiesalsodevelopedformalinstitutionstosupplementtheinformalreputationmechanismandcoordinateexpec-tations.Forexample,eachcommunityestablishedorganizationsthatenabledmem-bersofothercommunitiestoverifytheidentityofitsmembers.Ultimately,thegrowthoftradethatthisinstitutionenabledcreatedtheimpetusforitseventualreplacementbymoreformalpublic-order(state-based)institutionswhichcoulddirectlypunishtradersby,forexample,jailingthemorseizingtheirproperty.However,publicorderneverentirelyreplacesprivateorder:marketsinmoderneconomiescontainamixofprivate-orderandpublic-orderinstitutions,andtrans-actionsmayrelyonboth(Greif).Forexample,alendermayobtainacreditreportonaprospectiveborrowerfromaprivatecredit-ratingrmthatlacksanyenforcementpowerbeyondtheabilitytoshareinformation,butitmayalsorelyonstateenforcementtoseizetheborrowerscollateralifshefailstorepay.Asnotedintheprevioussection,withintheinstitutions-as-rulestradition,itiswidelyheldthattheboundarybetweenrmsandmarketsasalternativemodesoforganizingtransactionswillbedeterminedsoastoachieveefciency(minimizetransactioncosts).Fromtheperspectiveoftheinstitutions-as-equilibriaapproach,organizationsappearascomponentsofbroaderequilibria,interactingwithotherinstitutionalelements,andconstrainedbythepast.Inparticular,iftherearemanypossibleequilibria,thentheremaybedifferentcongurationsoforganizationsasso-ciatedwitheachoftheseequilibria,andthestructureoforganizations,includingtheboundariesbetweenrmsandmarkets,cannotthereforebededucedfromaknowl-edgeofthecharacteristicsofthetransactionalone.32A.GreifandC.Kingston Forexample,duringtheeighteenthcenturytheinstitutionsgoverningmarineinsurancetransactionsdevelopedindifferentwaysindifferentcountries.InBritain,acoffeehouse(LloydsofLondon)graduallydevelopedintoasophisticatedmarketplaceforunderwritingbyprivateindividualswhounder-wrotetheamo-untstheywerewillingtoinsureonpoliciespresentedtothembymerchantsorbrokers.Incontrast,inFrance,HollandandtheUS,privateunderwritingdisap-pearedandwasreplacedbyjoint-stockcorporations.Theunderlyingmarineinsur-ancetransactionswereplaguedbyseriousinformationasymmetriesandagencyproblems,includingthepotentialforvariouskindsoffraud.Eachinstitutionalformprivateorcorporateunderwritinghadadvantagesanddisadvantagesindealingwiththeseagencyproblems.Kingston(2007)arguesthattheindustrywascharacterizedbymultipleequilibria.InBritain,anequilibriumbasedonprivateunderwritingbecameinsti-tutionalizedovertimethroughthedevelopmentofspecializedinstitutions,inparticularLloydscoffee-house,whichbecameahubforinformationaboutshipsandtheircrews,politicalandeconomicdevelopments,andthemanyotherfactorsaffectingtheriskofavoyage,andalsoforinformationaboutthereputationsofmarketparticipants.ThisultimatelymeantthatinBritain,thecorporationssufferedalemonsproblembecauseoftheirinferioraccesstoinformationaboutvesselsandotherdevelopmentsaffectingtheriskofavoyage,enablingtheprivateunder-writerstodominatethemarket.Incontrast,intheAmericancolonies,althoughprivateunderwritinghadbeendevelopingrapidly,itneverreachedthelevelofcomplexityofLloyds.Instead,inthelate1790stherewasashiftbetweenequili-briaasprivateunderwritingwasextinguishedbycompetitionfromjoint-stockcorp-orations(Kingston).Kingston()showshowthetimingofaseriesofhistoricalevents,involvingbothexogenousshocks(suchaswar)andendoge-nousparameterchangesandlearningprocesses,drovetheprocessofinstitutionalchange(equilibriumselection),leadingultimatelytoapath-dependentbifurcationofinstitutionalstructurebetweenBritainandtherestoftheworld.Eachequilibrium,onceestablished,provedstable.Thus,althoughthefundamentalpurposeofthetransactionsharingriskwasthesame,bytheendoftheNapoleonicwars,themannerinwhichthetransactionwasaccomplishedwasverydifferentindifferentcountries.Thegovernancestructuresthatemergedweretheoutcomeofahistor-icalprocesswithmultiplestableend-points,ratherthanbeingdesignedtomini-mizetransactioncosts.5.3PoliticsAsnotedintheprevioussection,afundamentalrationalefortheexistenceofthestateisthatitcanuseitscapacityforcoerciontoprovideorderandsecurity.Manycontemporarysocietiesfacethechallengeofbuildingstatesthateffectivelypro-motepoliticalstability,curtailpoliticalviolence,andfostereconomicprosperity.Thishasprovennoeasytask,despitethefactthatcopyingformalrules,includingInstitutions:RulesorEquilibria?33 constitutionsandlaws,isrelativelystraightforward.Whydontcountrieswithinefcientorineffectivepoliticalstructuressimplycopytheinstitutionalstructureofmoresuccessfulones?Andwhydocountriesthattransplantformalrulesfrequentlyndthatthisfailstoreproducethedesiredpatternsofbehavior?Withintheinstitutions-as-rulesframework,theexplanationofferedisthatbeha-viorisconstrainednotjustbyformalrules,butalsobytheinformalrulespresentinasociety.Butaswesawearlier,thisleavesunansweredthequestionofwheretheseinformalrulescomefrom,andhowtherules,includingtherulesgoverningthebehaviorofthestateitself,areultimatelyenforced.Thekeypuzzleishowtoconstructastatethatisstrongenoughtoprovideorderandprotecttherightsofitscitizens,butinwhichpoliticalpower-holdersareneverthelessmotivatednottousethispowertoabusethoserights:inotherwords,allactors,includingrulers,mustobeytherules.Thus,astable,well-functioningpoliticalsystemshouldbeviewedasadesirableequilibriumoutcomeratherthanasasetofrules.Batesetal.()studyamodelinwhichplayerscanchoosetoallocatetheireffortamongthreegoals:production,leisure,andarmingthemselvestoengageinviolence.Acapacityforviolenceenablesplayersbothtodefendtheirownproduc-tiveoutputandtoraidtheoutputofothers.Inanarchy(asituationwithnostate),therearetwokindsofequilibria:oneinwhichthereislittleviolence,butalsolittleproduction,sothatmosteffortgoesintoleisure;andanotherequilibriuminwhichthereisproduction,butalsoalotofviolence,aspeoplewhoproducemustalsobewillingtodefendtheiroutput.AsintheHobbesianvision,thecreationofastateasaspecialistinviolencecanimproveefciencybyenablingplayerstoproducewith-outfearofbeingraidedbyothers.Inreturnfortaxingtheoutputoftheplayers,thestateundertakestopunishraiding.Batesetal.(),however,gobeyondHobbesinprobingtheincentivesofthestateitself;theyshowthatthestatecanbecons-trainedfrompredationbytheshadowofthefuture,sinceafailuretoprotectthepropertyrightsofthecitizenscanleadtoreversiontoawarlordequilibriuminwhichnotaxesarepaid,andtheplayersarmthemselvesnotjustagainstraidingbyotherplayers,butagainststatepredationaswell.Thus,thebalanceofcoercivepowerscansustainthestateasanequilibrium.Weingast()showshowtheruleoflawemergedasanequilibriumoutcomeofagamebetweenarulerandhissubjectsinseventeenth-centuryEngland.Theking(James)initiallysupportedtheinterestsofthelandedToriesattheexpenseofthemercantileWhigs,wholackedthepowertooverthrowthisrulingcoalition. Ofcourse,real-worldprocessesofstate-buildingdonotstartfromthecleanslateenvisionedbyHobbes.Bates()arguesthathistorically,monarchicalstatesemergedoutofcompetitionamongfeudallineagesasrural,agrariansocietiesbasedonkinshipnetworksbecameincreasinglyurbanizedandindustrial.Olson()providesanalternativeparablefortheoriginsofthestate,arguingthatthestateemergedasthosewiththegreatestcapacityforviolencefounditprivatelymoreprotabletousethiscapacitytoprovideorderinexchangefortaxrevenue,ratherthansimplytolivebyplunder.34A.GreifandC.Kingston However,afterthekingbegantoinfringeontherightsoftheTories,theWhigsandToriescombinedtooverthrowhim,andinstalledasuccessor(William).Atthesametime,theycreatedanewconstitutionwiththeaimofpreventingthekingfromfuturepredation.Thenewconstitution,Weingastargues,wasfundamentallyacoor-dinationdevicethatlaidouttheconditionsthatwouldtriggeracoordinatedreac-tionbythecitizensagainstthekinginfuture.Thereby,itenabledashiftfromanequilibriuminwhichthekingwasabletotransgresstherightsoftheWhigswithimpunitytooneinwhichtheWhigsandToriesundertooktojointlyresistanytransgressionbythekingagainsteitheroftheirrights.Toachievethis,thenewagreementneededtobeself-enforcing.Bothgroupsofcitizenshadanincentivetoabidebytheagreement,asafailuretodosowouldenablethekingtoabusetherightsofbothgroupsinthefuture.Thekingwasmotivatedtorespectpropertyrightsbythecredibleexpectationthatbothgroupswouldreactinconcerttoaninfringementoftherightsofeithergroup.Thus,asinBatesetal.smodel,whiletheplayersmayarticulaterulestogoverntheirbehavior,itistheultimatelythethreatofabreakdownofcooperationinaninnitely-repeatedgamethatenablesanon-predatorystatetobesustainedasanequilibriumoutcome.Greif(2006,Chap.8)studiestheprocessofstate-buildinginmedievalGenoa.Genoascommercialexpansionhadbeenhinderedbythethreatofconictbetweentworivalfeudalclans,whichledeachclantowastesubstantialresourcesdefendingitselffromtheother.Toachievegainsfromcooperation,thewarringclansagreedtoinviteanon-Genoeseruler/administrator,thepodesta,torulethecity.Theheldthebalanceofpowerbetweentheclans,butwasnotmilitarilystrongenoughtoimposehiswillonthemandbecomeadictator.Toavoidthedangerofthealigninghimselfwitheitherclan,heandhisfamilywereforbiddenfrominvolve-mentinGenoesesocietyorpolitics.Indeed,thepodestaspositiondependedonensuringthatneitherclanbecamedominant,ortheywouldhavehadnofurtherneedofhim.Thus,thepodesteriasystemwasasetofself-enforcinginstitutionsthatpromotedinter-clancooperationandreducedthethreatofconict.Theprocessofinstitutionalchangewasshapedbytheinitialconditions,includingthesetoforga-nizations(inthiscase,clans),andthefeudalrules,beliefs,andnormsinheritedfromthepast.ScartasciniandTommasi()studyamodelofpolicymakinginwhichindividualscaneitherpursuetheirinterestsviatheformalpoliticalprocessorthroughviolence,protests,bribery,andsoon.Theyshowthattheremaybemultipleequilibria:oneequilibriuminwhichallplayerschooseformalchannels,andanotherinwhichsomeplayersusetheformalprocess,butmanyplayersgotothestreets.Moreover,thestabilityoftheseequilibriaisreinforcedbyactorsinvestmentsovertime.Theirmodelcanaccountforthedifferencesinobservedpoliticalbehaviorbetweencountrieswithsimilarformalrules(suchastheU.S.andArgentina)butthesebehaviorsareexplainedasequilibriumoutcomesratherthanbyinvokingdifferencesinunobservableinformalrules.Institutions:RulesorEquilibria?35 6Institutions-as-Equilibria:TheFrontier6.1Beliefs,Culture,andInstitutionalTrajectoriesIntheinstitutions-as-rulesperspective,beliefsinuencebehaviorthroughtheirimpactonthechoiceofrules.InNorth(2005)sframework,economicagentshavementalmodelswhichreecttheirunderstandingoftheworldandwhichtheyusetoevaluatethedesirabilityofparticularrulechanges.Overtime,astheylearnabouttheworld,theyrevisetheirmentalmodels,andthismayaltertheirperceptionsaboutthenetgainsfromalternativepossiblerules,orleadthemtoperceivenewpossiblerules,leadingthemtotrytochangetherules.Thus,thekeytounderstandingtheprocessofchangeistheintentionalityoftheplayersenactinginstitutionalchangeandtheircomprehensionoftheissues(North2005,p.3).Theinstitution-as-equilibriaperspectiveemphasizesadditionalcausalrelationsbetweenbeliefsandoutcomes.Beliefsmotivatepeoplesbehaviorbyinuencingtheperceivedcostsandbenetsofvariousactions,includingexpectationsaboutothersbehavior.Beliefsmatterbecauseindividualshavepotentiallylimitedanddifferentinformation,knowledge,andcognitiveunderstandingabouttheenviron-mentandthestrategiesofotherplayers.Rulesprovideonemeansforpeopletocoordinatetheirbeliefs.Consider,forexample,theseeminglyunnecessarylawspecifyingthedirectionoftrafc(driveontheleft,ordriveontheright).Suchatrafclawprovidesnewdrivers(orthosevisitingfromabroad)withtheknowledgerequiredtomakeaninformeddecisionbasedonaminimalunderstandingofthesystem.Furthermore,becausesuchrulesspecifyself-enforcingbehavior,agentsaremotivatedtoacquireknowledgeoftherulesandfollowthem.Theanalysisoftheprocessesthroughwhichrulesaggregateknowledgeandinformationisinitsinfancy.AnotablecontributionisAoki()whoproposesthatasanexistingequilibriumbreaksdown,cognitivelylimitedagentsperceivethattheirformerstrategiesarenolongoptimal,withoutnecessarilyunderstandingwhy,andbegintoexperimentwithnewstrategies.Astheirbehaviorandexpectationschange,institutionalchangeamovementtoanewequilibriumoccurs.Eventu-ally,agentsstrategiesandbeliefsystemsarebroughtbackintoalignmentwitheachotherasmutuallyconsistentcomponentsofanewinstitutionalequilibrium.Greif()proposesasocial,ratherthanindividualisticprocessoflearningandconvergence.Agentsrespondtotheexpectedbehaviorofothersasarticulatedinaknownruleofbehavior(eitherformalorinformal).Thetrafc-lawspecifyingaspeedlimit,forexample,constitutesasocialrule,knowntothedriversandtowhicheachofthemresponds.Theirresponsesleadthemtochooseaspeedhigherthanthelegalmaximum.Butthisisnotexplainedbyassertingthatthereisahiddeninformalrulespecifyingtheobservedbehavior.Rather,asplayersobservebeha-viorandoutcomesovertime,theinstitutionalizedrulesoftheroadwhichdevelopreectthedispersedbeliefsandinformationofindividualsrespondingtoastructurewhichissimultaneouslycreatedbytheiraggregatedresponsestothestructureitself.36A.GreifandC.Kingston Theinstitutions-as-rulesapproachmakesacleardistinctionbetweenformalrules,whicharecreatedinparticularbythestate,andculture,whichconsistsofinformalrulesformulatedbysociety.Incontrast,thedistinctionbetweenrulesandcultureintheinstitutions-as-equilibriaapproachisoneofkindandnotoneofessence.Bothrulesandcultureinuencebehaviorbygivingrisetosharedbeliefs,norms,andexpectationsthatgenerateregularitiesofbehavior.Thisfacilitatesstudyingtheinter-relationsbetweeninstitutionsandculture.Clearly,neitherculturenorinstitutionsareimmutable.Therearemanyhistoricalexamplesofrapidculturalchange.Yet,totheextentthatoneassociatesculturewithinstitutionalelementsthatprevailedpriortostateformationoremergeindepen-dentlyofit,distinctculturescanleadsocietiesalongdistincttrajectoriesofinstitu-tionaldevelopment.Theperpetuationandimplicationsofbothinstitutionsandculturedependonthecontext,unintendedconsequences,andhistoricalcontingen-ciessuchasthesequenceofvariousexogenousevents,leadership,andtheoutcomesofmilitaryconicts.Culturalchangeandculturesimpactarenotdeterministic,butaspecicculturecanrendersomeinstitutionaltrajectoriesmorelikelythanothers.BenabouandTirole()giveanexampleofhowmultipleequilibriacanresultfromthetwo-wayinteractionbetweensharedbeliefsandpublicpolicies.Theyarguethatinsocietieswheremanypeopleholdabeliefinajustworldthebeliefthateconomicsuccessishighlydependentoneffortthesepeoplewillfavorlowlevelsofredistributionandlowtaxrates.Thesepoliciesincreasetherewardtoeconomiceffort,givingpeopleanincentivetoadopt(andteachtheirchildren)thejustworldideology.If,instead,peoplebelievethatluckplaysmoreofaroleindeterminingindividualsuccess,theymayfavorhigherlevelsofredistribution,whichdampenstheincentivesforhigheffort,conrmingthebasesfortheirbeliefs.Notethattheseideologicalbeliefsaremorethanjustareectionofdifferentinstitutionalstructures.Theyareafundamentalpartofeachequilibrium.Greif()showedhowdistinctculturalbeliefsledtodistinctdevelop-mentsofcontractenforcementinstitutionsamongeleventhcenturyJewishmerch-antsoperatingintheMuslimworldandtheLatin-ChristianGenoese.Collectivismamongtheformerfosteredrelianceonenforcementbasedonamultilateralreputa-tionmechanismwhileindividualismamongthelatterfosteredenforcementbasedonbilateralreputationandthelaw.Thelattersrelianceonthelaw,inturn,wasfacilitatedbythefactthatitwasaman-madelawandnotadivinelaw.ThisfundamentaldistinctioninlegalconceptionswasnotinstitutedbystatesorrulersbutreectedthedistincthistoricalprocessesthroughwhichChristianityandIslamemerged.6.2MoralNormsandEndogenousPreferencesAsecondfrontierissueintheinstitutions-as-equilibriaapproachistheinter-relationsamonginstitutionsandpreferences.Althoughsomeaspectsofindividualpreferences,suchasthosedirectlyrelatedtosurvival,areprimordialandselsh,Institutions:RulesorEquilibria?37 otheraspectsofpreferencesareshapedbysocietybecausehumanshaveother-regardingpreferencesandseekmoraljusticationfortheirbehavior.Thecrucialelementhereisinternalizedmoralnormsorvaluesthatindividualsarepsychologi-callymotivatedtofollow.Aninternalizednormagainststealing,forexample,placesawedgebetweenthenetutilityvalueofvedollarsearnedandvedollarsstolen.Suchmoralnormsbasedonintrinsicmotivationaredifferentfromsocialnormswhichrelyonextrinsicmotivationprovidedbythethreatofnon-legalpunishments.Moralnormsinuencebehaviordirectlythroughtheirimpactonpreferences,andindirectlybyinuencingtheexpectedbehaviorofthosewhoareperceivedtohaveinternalizedsuchnorms.Peoplearebornwiththecapacityandthepropensitytointernalizenorms,andabsorbnormsthroughsocializationbyrolemodels,parents,peersandorganizations(suchasschoolsandchurches).Institutionscaninuencenormsthroughtheirimpactonthesesocializingagents.Tabellini()providesawonderfulanalysisofhownormsofgeneralizedorlimitedmoralitycanevolveinthesamesituationdepend-ingontheincentivesinstitutionsprovidetoparents.Specically,aparentfacesatrade-offbetweensocializingherchildtohavehernormsorsocializingthechildtohavethenormswhichwouldbeoptimalforthechildinthefuture.Institutionsinuencethistrade-off.AkerlofandKranton()discussthevalueofintrinsicmotivationwithinorganizations.Theyusethemilitaryasacompellingexampleofanorganiza-tionwhosemembersareprimarilymotivatedbynon-monetaryincentives(suchashonor).Suchatheoryofmotivationhasimportantimplicationsfororganiza-tionaldesign.Forexample,employingasupervisortomonitoraworkerseffortmayenablethermtomotivatetheworkerusinghigh-poweredmonetaryincen-tives,butKrantonandAkerlofarguethatthereisalsoahiddencost:hiringthesupervisormayalsoreducetheemployeessenseofidenticationwiththermanditsgoals,therebyerodingthermsmotivationalcapital(workersloyalty).AkerlofandKrantonsworkisrelatedtoanemergingliteratureonendogenouspreferences,muchofwhichusesevolutionaryargumentstoinvestigatetheroleinstitutionsplayinmoldingnotjustpeoplesbehavior,butalsotheirgoals(Bowles1998).Thesetheoriesemphasizethatwhileinstitutions,beingman-made,arecreatedthroughhumanaction(whetherintentionalornot),institutionsalsoplayaroleinreconstitutingthegoalsandperceptionsoftheindividualstheygovern.Theinte-grationoftheseconsiderationsintheinstitutions-as-equilibriaperspectiveisinitsinitialstages.Ifsuccessful,itwillimproveourabilitytostudynormsasoneelementinalargersysteminwhichpeoplearemoral,yetmaterialistic,andmotivationisprovidedbyendogenousbeliefs,norms,andexpectations.6.3Origin,DynamicsandComplementaritiesTheinstitutions-as-rulesapproach,aswehaveseen,studiesinstitutionsas(exoge-nous)constraints(rules)leadingto(endogenous)behavior,whileenforcementoftherulesistreatedasaseparateissue.Institutionaldynamicsisfundamentallyabout38A.GreifandC.Kingston changingrules,andtheanalyticalfocusisonchangingformalrules.Incontrast,theinstitutions-as-equilibriaapproachfocusesonthebehavioralmanifestationsofendogenousmotivation;how(endogenous)behaviorgenerates(endogenous)insti-tutionsthatperpetuatethisbehavior.Institutionaldynamicsisthereforefundamen-tallyaboutchangesinmotivationandregularitiesofbehavior,andtheanalyticalfocusisonchangesinbeliefs,norms,andexpectations(GreifandLaitinTwocausesofinstitutionalchangeareparticularlyimportant.Therstisanintentionalattempttobringaboutchangebythosewhorealize(orhope)thattheycanbenetfromit.Thiskindofinstitutionalchangecanresultfromtheperceptionofnewinstitutionalpossibilities,perhapsbroughtaboutbylearningorbynewinteractionswithoutsiders.Becausetheexistinginstitutionsareequilibria,how-ever,theygenerallycannotbechangedunilaterallybyasingleactor.Bringingaboutachangemaythereforeinvolveovercomingcollectiveactionproblemsaswellasovercomingtheoppositionofthosewhostandtolosefromthechange.Suchcollectiveactionmayoccurthroughpersuasionorthroughtheuseofneworexistingorganizations,or,lesscommonly,throughtheriseofacharismaticleader.Thesecondmaincauseofinstitutionalchangeisinstitutionaldisequilibriumwhichresultswhenaninstitutionceasestobeself-enforcing.Thiscanoccureitherduetoexogenousshocksorduetoendogenouschangesinquasi-parameters(GreifandLaitin):variableswhichchangegraduallyovertimeasaresultoftheoperationoftheinstitutionitself,andmayultimatelypassacriticalthresholdsothattheinstitutionceasestobeself-enforcing.Whetherthesubsequentinstitutionalchangeisgradualorabrupt,evolutionaryorintentionaldepends,inparticular,onwhethertheactorsarecognitivelyawareoftheprocessleadingtochange,whoisawareofit,andhowtheycaninstitutionallyrespond.Thedetailsoftheresultingnewinstitutions,iftheyleadtotheintendedout-comes,arepartiallydictatedbythefunctiontheyhavetoserve.Yet,therearemanyinstitutionsthatcanachievethesameobjectives.Fromtheinstitutions-as-equilibriaperspective,pastinstitutionalelementsinuencethedetailsofsubsequentinsti-tutionsbecauseinstitutionalizedbeliefs,norms,andexpectationsareembodiedinpeoplesbeliefssystems,preferencesandmemories,whileexistingorganizationshaveenduringphysicalcapacities,routines,andotherresources.Althoughitmaybetechnologicallypossibletocreatenewbeliefs,norms,expectationsandorgani-zations,doingsoisusuallycostly,timeconsuming,andrequiresventuringintothecognitivelyunknown(GreifThereisthereforeafundamentalasymmetrybetweeninstitutionalelementsinheritedfromthepastandtechnologicallypossiblealternatives.Pastinstitutionalelementsaretherawmaterialonwhichnewinstitutionsarebased.Sugden(arguesthatpeoplewishingtocoordinatetheirstrategieswillgenerallyadoptruleswhichareanalogoustoruleswithwhichtheyarealreadyfamiliar,forexample,therstcome,rstservedrulewhichisusedtoassignpropertyrightsinmanysituations(andtherebyavoidpotentiallycostlyconict).Greif()arguedthatorganizationsinheritedfromthepastandculturalbeliefsdetermineselectionamongalternativeinstitutions.Patternsoforganizationalmembershipdeterminewhoseidentityisknowntowhom,andwhereinformationows,whileculturalbeliefsInstitutions:RulesorEquilibria?39 coordinateexpectations.Campbell()arguesthatactorsoftencreatenewinstitutionsthroughaprocessofbricolage:recombiningelementsintheirinstitu-tionalrepertoiretodealwithnewsituations.Newinstitutionsoftenresembleolder,familiarinstitutionsbecausetheycontainelementsinheritedfromorinspiredbypastinstitutions.Greif()delineateshowexactlypastinstitutionalelementsinuencesubsequentinstitutionsthroughtheirenvironmental,coordination,andinclusioneffects.Thus,theinstitutions-as-equilibriaapproachconceptualizesinstitutionaldynam-icsasanaccumulativehistoricalprocessofinter-relatedinstitutionalelements.Pastinstitutionalelementsareincorporatedintonewinstitutionsthatemergewithinthecontextofandhencearecomplementarytoexistinginstitutions.Theresultsareinstitutionalcomplexes,whichareasetofinstitutionsthatgovernvariousinterac-tions,havecommoninstitutionalelements,andarecomplementarytoeachother.Societysinstitutionshavetobestudiedfromaholistic,systemicperspective(Aoki7ConcludingNotesRecentscholarshiphasdemonstratedthepoweroftherationalchoiceframeworkforadvancingourunderstandingofinstitutionsandinstitutionalchange.Andasourunderstandingimproves,theconceptualframeworksemployedtostudyinstitutionscontinuetoevolve,enablingustodevelopricherandmorecompleteanswersevenasweprobedeeperandmorecomplexquestionsaboutthenatureofinstitutionsandprocessesofinstitutionalemergenceandchange.Fromtheinstitutions-as-rulesperspective,institutionsarerulesthatareeitheroptimalresponsestotheinstitutionalenvironmentoraredeterminedbytheinterestsofthepoliticalactorswhomaketherules.Thisapproachhasbeenfruitfullyapp-liedtoexplorehowtherulesofthegameareformedindiversesettings.However,becauseenforcementoftherulesistreatedasexogenous,theinstitutions-as-rulesapproachworksbestinsituationswherethereare,infact,well-functioningandtransparentenforcementinstitutionswhichcanbetakenasgiven,andinwhichtherules(whetherformalorinformal)areeasytoobserve,sothattheymaybeexpectedtotranslatemoreorlessdirectlyintoeffectsonhumanbehavior.Iftheseconditionsarenotmet,thenultimately,toexplainhowtherulesareenforced(ornot),andwhytheyarefollowed(ornot),theinstitutions-as-rulesframeworkmustbesupplementedorreplacedbyatheoryinwhichenforcementistreatedasendogenous,andtheincentivesofallplayerstofollowtherulesareexplainedratherthanassumed.Theinstitutions-as-equilibriaapproachfocusesonmotivationprovidedbybeliefs,norms,andexpectationsthatbothshapeindividualbehaviorwhilstsimultaneouslythemselvesbeingaproductofthestrategicinter-playbetweenagents(individualsororganizations).Thus,boththecontentoftherules(behavior)andtheirenforcement(peoplesmotivationforfollowingthem)canbestudiedwithinauniedframework.Thekeytoinstitutionalchange,from40A.GreifandC.Kingston 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