The Rise of the Western World: A New Economic History

Douglass C. North and Robert P. Thomas

Cambridge University Press, 1972; Pp. 179

The development of an efficient economic organization in Western Europe accounts for the rise of the West. Efficient organization entails the establishment of institutional arrangements and property rights that create an incentive to channel individual economic effort into activities that bring the private rate of return close to the social rate of return (p.1).

Theory

Economic growth occurs if output grows faster than population, which will occur if property rights make it worthwhile to undertake socially productive activity. The creating, specifying, and enacting of such property rights are costly, affected by the state of technology and organization. As the potential grows for private gains to exceed transaction costs, efforts will be made to establish such rights. Governments take over their protection and enforcement because they can do so at a lower cost than private volunteer groups. However, the fiscal needs of the government may induce the protection of certain property rights which hinder rather than promote growth. Therefore, there is no guarantee that productive institutional arrangements will emerge (p.8).
Growth will not occur unless the existing economic organization is efficient. Individuals must be lured by incentives to undertake socially desirable activities. Some mechanism must be designed to bing social and private rates of return into closer parity. Private benefits or costs are the gains or losses to an individual participant in any economic transaction. Social costs or benefits are those affecting the whole society. A discrepancy between private and social benefits or costs means that some third party, without their consent, will receive some of the benefits or incur some of the costs. Such a difference occurs if property rights are poorly defined or not enforced. If private costs exceed private benefits, individuals will not undertake the activity, even if it is socially desirable (p.3).
There are two major reasons why property rights may not evolve to bring private returns into parity with social returns: (i) techniques may be lacking to counteract the free-rider and/or compel third parties to bear their share of the costs of transaction; and (ii) the costs of creating or enforcing them may exceed the benefits to any group or individual (p.5).
Property rights are embedded in the institutional structure of society and the creation of new rights demands new institutional arrangements, particularly those which enable units to (i) realize economies of scale, (ii) improve the efficiency of factor markets, (iii) encourage innovation, and (iv) reduce market imperfections.
The creation of organizations involves real costs; new institutional arrangements will not be set up unless private benefits of their creation promise to exceed the costs: (i) devising new arrangements takes time, thought, and effort (i.e. it is costly) but since everyone can copy the new form without compensating the individual(s) who devised it, there will be a substantial difference between private and social benefits and costs; and (ii) governmental solutions entail the additional cost of being stuck with the decision in the future (p.6).
A government is an organization that provides protection and justice in return for revenue. Justice and enforcement of property rights are public goods publicly funded. Governments were able to define and enforce property rights at a lower cost than could voluntary groups, which gave these groups an incentive to trade revenue (taxes) in return for rigorous definition and enforcement of property rights by government.
There is no guarantee that governments will find it in their interest to protect these property rights which will encourage efficiency against those, which may thwart growth altogether (p.7).

History

End of Early Middle Ages, 900. The contractual arrangement of the classic manor is the efficient arrangement for its day. The obligation of the serf to provide labor services to his lord and protector, an input-sharing arrangement, was chosen because given the constraint of high transaction costs involved in trading goods, it was the most efficient.
The almost total absence of a market for goods, plus the existence of a rudimentary market for labor, ensured that inputs could be shared with lower transaction costs. Competition between lords for labor restrained their natural bargaining power.
The same conditions responsible for manorialism also explain feudalism. The necessity was obvious to maintain a quasi-national or regional governmental defense against organized invasions and to adjudicate disputes between lords. Without a market, maintaining a mercenary army would entail significant transaction costs. Feudalism saved on these costs: the granting by the king of large areas to be organized as petty kingdoms provided the lords with a great deal of economic and political power. As a protection against a coalition of lords, the king had to remain a large landlord himself (p.32).
High Middle Ages, 10th-12th Century. From the 10th century onward, population expanded, regional and interregional commerce revived, new techniques were developed, and both manorialism and feudalism were changed.
A high rate of natural increase in population was made possible by the abundance of virgin land. Co-extensive with population growth, commerce began to push outward, spreading with the new settlements. The rise of trade within Northern Europe was accompanied by the establishment or revival of urban places. Some technological innovation occurred (water and wind replaced human and animal power, the three-field crop rotation system).
Both lords and serfs were attempting to obtain concessions from one another, to define legally the uses to which the land and labor could be put, and to determine who was entitled to these privileges. The labor dues owed by the serf were being commuted or transformed into annual money payments. The lord's demesne tended to be leased out in return for money rent payment.
The relationship between king and lords also changed, with a money payment (scutage) beginning to replace the traditional obligations (p.35).
Thirteenth Century Europe. End of the frontier movement, but not of population growth. Urban places expanded, trade and commerce flourished locally, regionally, and internationally. A dynamic era, the culmination of the expansion begun in the 10th century, and the autumn before the abysmal 14th century.
The rapid growth of population relative to the fixed supply of land accounted for the pattern of economic growth. As population continued to grow, the marginal productivity of labor declined and wages fell relative to the value of land. The price for agricultural goods, produced under conditions of diminishing returns, increased compared to non-agricultural goods not so burdened. A per capita decline in productivity in the dominant sector of the economy meant less output for each person engaged in agrarian pursuits. The more abundant crops needed to feed the growing population demanded a redistribution of income between land and labor. The rewards to labor declined while land brought even greater returns to its owners. The bulk of the population suffered a sharp decline in economic welfare. Even the benefits of commerce and technology were swamped by the effects of population growth on overall productivity (p.52).
Powerful stimulus toward the growth of larger political organizations due to (i) growth of trade and increased demand for protection of private property in long-distance trade; and (ii) consequences of a money economy upon the minimum efficient size of military units (p.65).
Fourteenth and Fifteenth Centuries. Population sharply declined in the wake of famine, pestilence, war, and revolution. The price of labor rose relative to that of land, general price level also increased, leading to depression of trade.
The significant and prolonged decline in population induced three shifts which account for the changes in institutional arrangements: (i) alteration of relative factor prices with rents falling relatively to labor, with the consequent decline in feudal revenues dependent on those rents; (ii) relative increase in the minimum necessary level of government expenditure; and (iii) the rise of transaction costs of using the market to organize economic activity (p.79).
These necessitated several institutional changes: (i) life leases as a way to retain tenants by lowering rents and reducing servile obligations; (ii) the rise of the nation states to eclipse city states (p.80).
Early Modern Period, 1500-1700. At the end of the 15th century, the population of Europe began to recover from the Malthusian checks. It grew during the 16th century but that changed sharply during the 17th. The Dutch United Provinces and England and Wales continued to grow, the populations of Italy and France stagnated, while those of the Spanish Netherlands, Spain, and Germany even declined (p.106).
The general rise in price level during the 16th century was universal. The price of agricultural goods increased relative to manufactured goods, and rents of land increased more rapidly than wages. The real wages of labor declined significantly. Trade flourished.
In sum, the balance sheet shows the declining productivity in agriculture, constant productivity in manufacture, and increasing productivity in the transaction sector of the market. Unfortunately, efficiency gains were not able to offset productivity declines and the 17th century suffered from the Malthusian checks of plagues and famines.
Some areas (England) emerged relatively unscathed, while others (Spain) were decimated. The efficiency of economic organization played a large part in determining the effectiveness of the Malthusian checks. Unlike the 14th century, when all economies were organized quite uniformly, by the 17th century, institutions and property rights in emerging nation-states had been taking divergent paths for 100 or 200 years (p.115).
1. France and Spain. The failure of both economies to exhibit long-run sustained economic growth was a failure of the two states to develop an efficient set of property rights.
  In the French case, factor markets, except for capital, moved ahead; property rights in land were established and protected; the product market, however, continued to be imperfect due to guilds, monopolies, and protection of local markets; as a result, the gains available from the transaction sector were lost to the French economy (p.127).
  In the Spanish case, decrees favoring the Mesta thwarted the development of efficient property rights in land; as the Crown's financial difficulties mounted, seizure, confiscation, or the unilateral alteration of contracts became recurrent; as a result, people were driven out of productive pursuits and economic retardation was inevitable (p.131).
2. The Netherlands and England. Both states remove the hindrances to allocation of resources in factor and product markets, establish efficient property rights, and develop markets that reduce transaction costs significantly thereby allowing them to achieve productivity gains, which enable them to offset the Malthusian checks and experience sustained economic growth.
  In the Dutch case, the growth of European population worked to their benefit; the market (transaction sector) which linked agriculture and industry with one another and with the consumer was the sector where large gains in productivity could be made; this sector was most important for the state, which thus had incentives to provide measures to stimulate commerce; commerce and continued warfare in Europe lead to the development of a capital market; industrial production became larger and more specialized; thus, the Netherlands was the first country to achieve sustained economic growth (p.135).
  In the English case, the construction of a world empire and imitation of Dutch property rights and institutional arrangements finally propelled England to dominance by 1700; the reduced cost of using the market was the main source of productivity gains; a series of successive approximations toward exclusive property rights in land developed in cultivated areas and set the stage for the agricultural revolution of the 18th century; industrial production became specialized geographically; the Statute of Monopolies ended the Crown's prerogative in creating monopolies and encouraged invention and innovation; thus, after an inauspicious start, by 1700 England was experiencing sustained economic growth (p.152).
By the 18th century, a structure of property rights had developed in the Netherlands and England which provided the incentives necessary for sustained growth. These included inducements required to encourage innovation and the consequent industrialization. The industrial revolution was not the source of modern economic growth, but the outcome of raising the private rate of return on developing new techniques and applying them to the production process (p.157).

February 19, 2002

@book{north-thomas-72,
  title     = {The Rise of the Western World: A New Economic History},
  author    = {Douglass C. North and Robert P. Thomas},
  year      = {1972},
  publisher = {Cambridge University Press},
  address   = {Cambridge},
  isbn      = {0-521-29099-6},
  note      = {Pp. 179}
}