Title: The Institutional Revolution: Measurement and the Economic Emergence of the Modern World
Author: Douglass Allen
Scope: 3 stars
Readability: 4 stars
My personal rating: 4.5 stars
See more on my book rating system.
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Topic of Book
Allen explains how institutions functioned in pre-Industrial Britain.
The title of this book is quite deceptive. The vast majority of the book describes how institutions functioned before the Industrial Revolution in Britain. Relatively little of the book describes how institutions changed afterwards.
- Pre-industrial societies had strong social class structure where a large gulf separated ordinary people from the elite, and seldom did one cross over from one station to the other.
- Institutions hired, fired and promoted based upon patronage, not merit. Patrons expected loyalty from their clients. It was assumed that clients would use their offices for personal gain (what we would call “corruption” today).
- Persons sought a higher office because they came with privileges that gave them a greater social prestige and income.
- The major problem of the pre- modern world was the enormous role nature played in the ordinary business of life. Keeping time, measuring distances, and relying on a power source were once problems of a first order.
- So patrons needed to align their client’s incentives to match their own. In this way, the patron could assume the client was working towards the patron’s interest.
- Most high- and medium-level appointments were reserved for nobility.
- To maintain their honor within the group, nobles were expected to:
- Strong sense of personal honor
- Socialize only with other nobles
- Educate their children in elite public schools that cultivated few practical skills.
- Maintain vast (and expensive) manor houses.
- Spend lavishly on parties and social entertainment
- Generate their income solely from land rents and public office.
- Forego investment in industry or trade.
- These beliefs insured that any disloyal nobles would love everything if they were disloyal to the crown.
Important Quotes from Book
This book is laced with the idea that institutions are “constrained efficient.”
Rather, it means that in the Darwinian struggle between nations, firms, and individuals, societies are driven to find institutions that get the job done best under the circumstances faced at the time. Institutions are arrived at in many ways, often by accident or by trial and error. When they work well relative to the competition, they tend to survive and the society prospers. There may be other institutional arrangements that might be technically feasible, but under the circumstances they are not economical.
Over time, I have come to realize that between roughly 1780 and 1850, the world experienced what can only be called an “Institutional Revolution.”
There was a distinct change, especially in the sector of the economy we call the “public service.” The economic world had been evolving, but during the period from 1780 to 1850 it reached an organizational tipping point. And the changes were, indeed, revolutionary. This revolution not only changed the way Western countries organized life, but as I speculate toward the end of the book, it may be the key to understanding why the other revolution— the industrial one— had the impact it did.
A patron was almost always necessary for any advancement in what we would now call the “public service.”
Patronage appointments were given to people whom the patron could trust; ability was a distinctly secondary matter. What was also strange about Pepys’s office, along with most others of the age, was that it became a matter of (mostly) private property once received. When Pepys became the clerk of the acts, he owned the office the way we now own our homes: he could sell, borrow against, and earn an income from it.
Economics provides a useful tool for understanding the past because the human experience, over time, is connected through a common economic reality. At the most fundamental level, all people at all times have dealt with the problem of scarcity. There has never been enough, there will never be enough, and as a result people always have been driven to find better ways to increase their wealth and consumption. Scarcity has several universal implications: choices always have had to be made, trade-off s always have existed, actions always have had costs, and there always have been winners and losers... Humans havealways used innovations to reduce the level of scarcity; thus technology, which is ever present in one form or another, has improved over time.
Not so long ago there was a strong social class structure where a large gulf separated ordinary people from the elite, and seldom did one cross over from one station to the other. Masters controlled servants, and both knew their place in the world. Merit was valued, but it was not the coin of the realm— personal connections, conduct, and birth mattered much more.
The institutional landscape was shockingly different in the pre- modern world.
Amazingly, our Western world has been institutionally modern for only a short period.
Much of the organization of life was different in the pre- industrial world, and a modern time traveler would be hard- pressed to fit in or understand it all. The institutional reality is that around 1850 the modern world— the world containing the modern institutions we are accustomed to— emerged.
My purpose here is to make the general claim that “measurement costs” are the common source behind the Institutional Revolution that troubled Marx and Engels. Free trade and the ability to socially interact with only “naked self- interest” and “callous cash payment” required the ability to mea sure what was being traded. Until this ability to measure materialized, communities required “patriarchal relations,” “feudal ties,” and “chartered freedoms” to get many things done.
I argue that many pre- modern institutions— at least the ones we find strange and fascinating— fall into two broad classes. In one class were those institutions based on what will be called “trust” between a patron/ master and his servant. Although there were many trusting institutions, in this category I examine only a few exemplars: the aristocracy, dueling, and the patronage system. In the other class were institutions designed to exploit the entrepreneurial spirit of private incentives. Here an office was sold to its holder, and these were known as “venal” institutions. Here I examine the purchase of military commissions, the purchase of private offices, and the private investigations of crime. The general claim is that the use of trust and private incentives were the Crown’s two main institutional tools against improper behavior on the part of its servants within a world where measurement of many daily, basic things was difficult and/or often close to meaningless.
Their details were designed to solve incentive problems that arose in the pre- modern world; that is, to generate wealth through reduced shirking, pilfering, embezzlement, theft, dereliction of duty, cowardice, and the host of other bad behaviors that arise when people come together for one reason or another. The reason why the pre- modern world had institutions different from the modern world was simply because circumstances were different. The reason why the Western world went through an Institutional Revolution was because those circumstances changed. And the most important circumstance to change was the ability to mea sure basic fundamentals such as time or distance. This economic framework not only provides a unified theory for many pre- modern institutions and their transition to modern ones but explains the nitty-gritty institutional detail that separates the pre- modern world from our own.
Measurement is necessary because we want to know things, and when interacting with other people what we often want to know is whom to blame. A fundamental problem in any life fraught with human interaction is this: Who is responsible for the bad outcomes and the good? Who is to be punished or rewarded? Choose any area of life and this problem is never far from the surface.
Part of the problem is that we lack the all- knowing powers of gods, but another part lies in the simple reality that nature plays an active role in life.
Whenever there is a problem, there are almost always two potential sources— man and nature— and we often cannot separate and measure their relative contributions.
Confusion over responsibility for an outcome creates an incentive for what we’ll call “bad behavior” on the part of a servant or agent.
Now we come to one of the big, mostly unnoticed, punch lines of history: the role of nature and variability was much different in the pre- modern world than it is today. Given that progress has been often little more than the removal of randomness in outcomes, over the past 200 years there has naturally been a reduction in the role of nature. Whenever a new technology or procedure was developed there was an increase in performance and a lowering of average costs, but there was often a shrinkage in the variance of outcomes as well. Life became more predictable, and nature played a smaller role. When nature’s ability to generate variability was reduced, then the ability to act badly changed. This had important implications for the types of institutions that were created. Institutions that would have been disastrous and unthinkable with high variability became viable under the new state of things. Likewise, institutions designed to handle large roles of nature became too costly in a more predictable world. The end of the eighteenth century saw a radical change in the role nature played in life, and it was this radical change that led to the Institutional Revolution.
In the pre- modern era, prior to the Industrial Revolution, almost everything in life involved a large natural component— variance was everywhere, and this led to high variability in the quality of everything produced. It also meant that measurement of an individual’s contribution to output was often almost impossible in some fields and nearly meaningless in others.
Patronage, in which individuals appoint, promote, and vouch for others they have a personal connection with, was common within the small, personal, and centralized governments of the pre- modern era. At the top of the civil ser vice was the King’s Household, which included all the Crown’s ministers who served at the plea sure of the monarch. The King’s House hold was the center of political and social life throughout the pre- modern era, and all major patronage appointments, from a jailer to a bishopric, would be discussed at the king’s court. Ministers and members of Parliament would control different parts of the government, depending on their influence. Powerful ministers possessed massive amounts of control. Patronage was passed down level by level: minister to court official, to deputy lieutenant, to sheriff , and to justice of the peace. From these positions, other positions of local government were then handed out to those in favor. The result was a very clannish form of administration, but one where “patrons were careful to select members whose views would not compromise their relations with the government.” Under patronage, reputation and social standing were central, and an appointment was made to an office based on the desires of the patron. The appointee was expected to act in the interests of the patron, and the entire system depended on the goodwill of its members and their ability to trust one another.
Although acts of patronage could be made to many members of society, the most important cases were reserved for the nobility.
The major alternative to patronage was to sell the office outright to a private individual. These were the venal offices, though at that time “venal” did not have the negative connotation it has today. When an office was sold it was generally treated as a form of property, no different from a landholding. The owner could manage the office as he saw fit, sell it, or leave it to an heir. When such an office was held, the owner could be absent and hire deputies to do the work. Most important, an office was a source of wealth, and remuneration was by fees, shares in revenues, gratuities, and perquisites rather than by salaries.
However, often the most important aspect to an office was the set of privileges that came with it. These privileges could have included freedom from certain taxes, access to bribes (which were legal), the ability to enter nobility (ennobling offices), local prestige, and inclusion in the ruling social class. Many of these privileges eventually led to other positions and offices that could generate income.
The Crown’s choice of offering an office as a form of patronage or as a venal office came down to what made the most wealth for the kingdom… It could hire workers at fixed salaries and monitor their performance (a professional bureaucracy). It could appoint individuals to certain positions in exchange for “loyal” ser vice (patronage). Or, the Crown could sell the franchise rights to individuals for fixed or shared amounts (sale of office).
In a nutshell, the major problem of the pre- modern world was the enormous role nature played in the ordinary business of life. Keeping time, measuring distances, and relying on a power source were once problems of a first order. Once these problems were solved, new institutions were developed that characterize the modern world. Those who lived in the pre- modern era did what all people do: the best they could with what they had.
It is difficult to grasp how dissimilar the world was prior to the Institutional Revolution because most of the differences manifested in subtle ways. This dissimilarity was most true in the case of the pre- modern era’s higher variability. Higher variability meant more randomness brought about by nature. Prior to the nineteenth century, nature played an enormous role in virtually every aspect of life… significantly. So great was the role of nature in the pre- modern era, and so hard to mea sure, that most people at the time simply never even tried. Nor did they have to because the ordinary business of life accepted the random changes that arrived daily.
On the eve of the Industrial Revolution, power was not only limited and low, but intermittent and unreliable.
Disease created randomness in life. One never knew if travels would bring an interaction with the dreaded virus, nor would the symptoms of an infection be known for weeks… the final outcome from an illness was unknown and varied widely.
As the Industrial Revolution progressed, the creation of steam power, continuous supplies of coal, and new methods of production meant that some industries could free themselves from the rhythm of natural power sources. Increased travel and road safety meant markets became bigger, supplies more regular, and inputs more consistent across long distances. Thus the increased division of labor, the increased use of machines, the use of nonseasonal sources of power, the better roads, and the use of standard inputs all led to a reduction in the role of nature throughout the Industrial Revolution.
The “pre- modern aristocrats” were an extremely small class of peerage and gentry families who ruled Britain, not with an iron fist, but through a social consensus between themselves, the Crown, the merchant class, and the vast numbers of commoners. Aristocrats existed across Europe, and though their immoderation differed in degree, their customs were similar enough that they could recognize each other as institutional cousins than almost any other social group before or since, their conduct as a class was governed by a set of unusual, strict social conventions and formal laws. These were not mere guidelines but rather strong social codes: if not followed, they could render a member a social outcast.
By 1880, the age of the aristocrats was essentially over, and by 1911, the Parliament Act made the House of Lords second fiddle to the House of Commons, driving the final nail in the coffin. After centuries, the rule of Britain peacefully transferred to commoners with no noble connections.
It is better to view the aristocracy as having three different institutional eras. These were the feudal lords (1066– c. 1550), the pre-modern aristocrats (c. 1550– c. 1880), and the modern aristocrats (c. 1880– present).
The relationship between nobles and Crown evolved substantially throughout the Middle Ages. The Magna Carta; the formation and evolution of Parliament; the erosion of feudal services, obligations, and benefits; the reduced importance of knights and heavy horse in combat; the War of the Roses (1455– 1489); and the general growth of the state all led to a relationship by the turn of the sixteenth century that had changed almost completely…. Henry VIII’s confiscation of monastery land, which accounted for up to 25 percent of En gland’s area, allowed him to create a relatively large number of new estates. These new estates were considerably smaller than those of the magnates, and by the mid-sixteenth century the pre- modern aristocrats began to emerge.
Unlike earlier lords who lived in castles and whose power was grounded in military force, the distinguishing feature of the new social elite was that its power was based on membership within a group supported by the Crown and by the general population, including wealthy merchants and professionals. The new aristocracy was held together by an implied social contract full of mutual obligations, responsibilities, and expectations; as a result, they lived in a country house and not behind a castle wall. It was this group that remained in power until replaced by bureaucratic and professional commoners beginning in the latter quarter of the nineteenth century.
As a result, the new aristocrats were not fundamentally soldiers but rather a group that provided ser vice to the Crown from the highest to the lower offices of the state. Indeed, their purpose for being was to fill the growing number of administrative offices of the state— and eventually there were hundreds of offices.
It was a long road to a peerage, and a potential entrant had to invest in certain ways while always under the observation of others in the aristocracy. The starting point in the journey was an investment in land. Land was always the defining attribute of the aristocracy— the test of rank and position… Thus the founding member of an aristocratic family seldom made it into the highest levels of society; instead, the newly rich spent time “building a manor house, extending the property, acquiring a coat of arms, inter- marrying with the local elite, and ensuring a proper education for the next generation.”
For example, many families emerged from the masses through success in some merchant enterprise. It was a standard expectation that the family would give up the occupation that earned the income necessary to purchase an estate if it wished to gain entry to the aristocracy. Similarly, investing in industry or commercial activity was frowned upon and could lead to a movement down in the social ranks.
Instead of special legal or landowner rights, the pre- modern aristocracy in En gland was about political power. By far the most important benefit was the right to serve in the King’s House hold and to be a member of Parliament either through the House of Lords or the House of Commons. Access to these seats of power meant control over lesser offices that were an important source of income and political support through grants of patronage.
It is hard to exaggerate the extent to which, by the end of the premodern era, the aristocracy ruled Britain and held power through its control over these civil offices. Both houses of Parliament were controlled by them until the turn of the twentieth century. The King’s House hold, which evolved into the executive arm of the government, was the domain of the aristocracy, as were the great offices and tenures of state. The army and navy officers were drawn from the aristocracy, as were the judges, justices of the peace, magistrates, and other local administrators. It is also hard to exaggerate the success of the aristocracy in generating wealth from these offices and from their vast estates. Aristocrats across Europe, and in En gland in particular, became the wealthiest members of society.
The pre-modern aristocracy was an institution— a system of constraints, beliefs, and social norms that was devised to control its members’ behavior in order to achieve an objective. These rules were designed by the Crown and the aristocrats themselves to fit the circumstances of a world where measurement of nature’s role was difficult and often meaningless.
The patronage system generated this trust through a simple idea: “Cheat me and you may gain for a while, but get caught and you’ll pay dearly.”
First, estates were isolated because urban centers offered a host of alternatives to elite living, which reduced the punishment of social ostracism.
Second, marriage into the aristocracy, even at the lower levels, meant that one’s social life was tied to the group. By forcing aristocrats to limit their social contacts, the punishment from being excluded increased.
Third, requiring a merchant family to give up its historical source of business removed the obvious exit strategy for cheating.
In contrast to slow and uncertain entry, exit from the aristocratic group was easy, quick, and usually permanent. A breach of trust, an adulterous affair, or the decline of a duel meant instant and complete exile from the aristocratic class.
When an aristocratic line went extinct, the estate reverted back to the Crown, and the entire bundle could be reinstated at a later time with the same title to a different family.
One of the distinguishing features of the aristocracy was the incentive not just to attend private schools and university but also to attend specific schools and focus on specific types of learning and social behavior… In particular, the emphasis was on knowledge that was not practical and had few alternative uses.
A proper education also meant that students went to the right schools. In the last half of the eighteenth century, 72 percent of peerage children attended Eton, Westminster, Winchester, or Harrow. Finally, a major part of a gentleman’s education came on the “grand tour,” where the young man would travel the Continent with a private tutor to “imbibe culture (and perhaps life experience) in foreign climes.” In the end, the aristocracy fostered a reputation for amateurism that encouraged pursuits that were unpaid and untrained for.
By forcing young aristocrats to invest in learning with little use outside of the elite group, the aristocracy increased the young gentleman’s investment in hostage capital. His educational investments would be of little value were he later caught cheating and was expelled from the group.
Expenditures on ostentatious living were visible sunk expenditures that acted as hostage capital.
Volunteer work and charity were other forms of sunk investments. Should an aristocrat ever be found faulty, there would be no recouping the investment in elaborate parties, gifts to the poor, or time spent on the bench.
Prior to the Industrial Revolution, the very wealthy in Britain were almost always members of the aristocracy.
The capstone feature of aristocratic life was the concept of honor. Honor and nobility went hand in hand and summarized the aristocratic lifestyle and values. It was expected that an aristocrat would be willing to defend his honor to the point of death, even over a minor slight of character. More specifically, death was to occur not in some random fashion but through a duel.
The duel was a way to make sure members of the aristocracy had invested in unobservable hostage social capital for the group. Failing to participate in a duel indicated that one was not trustworthy because aristocrats equated unwillingness to uphold one’s honor in this way with a lack of social capital. Although dueling was costly, it was productive in this screening way. Dueling helped the aristocratic class filter out low social- capital individuals who were interacting among them— pretenders.
The British navy was one of the largest and most significant premodern institutions involved in the patronage system.
By the end of the Napoleonic Wars, the British navy was arguably the largest organization in the world— employing tens of thousands of people. It was, by most accounts, “the largest industrial unit of its day in the western world, and by far the most expensive and demanding of all the administrative responsibilities of the states.”
The British navy was an effective fighting force, not because of its raw physical and human capital (the British were not naturally better sailors), but rather because of the set of rules under which the British fought provided incentives for the naval officers to train their crews and use their ships as an effective fighting force.