Adam Smith's and Douglass North's Multidisciplinary Approach to Economic Development

From an excellent paper by Kwangsu Kim in the The American Journal of Economics and Sociology (Jan. 2014):

Finally, it requires notice that with regard to the same stories just observed North recently proceeded to add an integral linkage between cultural artifacts and economic development (North 2005: 44, 135–145). North claimed that the success of Western Europe and the United States is based on a “competitive decentralized environment” with a flexible institutional structure and “modern perceptions of freedom,” which were created by the combined forces of “Christian dogma” and English “individualistic behavioral beliefs.” In contrast, why Spain and Latin America were slow to growth lay in an “absolutist,” “centralized monarchy and resultant bureaucracy” and “the evolution of the belief structure in ways that reinforced the existing institutional structure and stifled both economic growth and political/civil freedoms” (North 2005: 137, 144–145).

The abstract:

This article aims to point out Adam Smith's and Douglass North's multidisciplinary approach to economic development and history. Based on a philosophical link of methodological issues, Smith and North shared a conceptual framework and explanatory principles in common as well as similar historical illustrations. In terms of the use of comprehensive and integrated models of society, politics, and economy, they presented that economic development relies on how far congenial both institutional environments and sociocultural values of justice, liberty, security, and equality are to economic agents, allowing the interplay between economic performance and polity/culture. Meanwhile, these suggest a bridging role between old and new institutionalism, and, more importantly, a revival of Smithian moral philosophical tradition in the history of economics. 

It is amazing how much ground Adam Smith covered. Many of his arguments are the basis for large traditions in modern economics.  

Trust and Development: Full Circle?

I recently posted abstracts of two articles on trust: One reports that trust affects economic development via 1) institutions and the rule of law, and 2) education. According to  another one trust explains almost half of the variation of entrepreneurship activity in a sample of countries [a friend said this is a full circle for a theory of economic development]. 

In the latest number of the QJE, Bloom, Sadun and Van Reenen have a new article titled "The Organization of Firms Across Countries" (a draft is here), and they say:

We argue that social capital as proxied by regional trust and the Rule of Law can improve aggregate productivity through facilitating greater firm decentralization. We collect original data on the decentralization of investment, hiring, production and sales decisions from Corporate Head Quarters to local plant managers in almost 4,000 firms in the US, Europe and Asia. We find Anglo-Saxon and Northern European firms are much more decentralized than those from Southern Europe and Asia. Trust and the Rule of Law appear to facilitate delegation by improving co-operation, even when we examine "bilateral trust" between the country of origin and location for affiliates of multinational firms. We show that areas with higher trust and stronger rule of law specialize in industries that rely on decentralization and allow more efficient firms to grow in scale. Furthermore, even for firms of a given size and industry, trust and rule of law are associated with more decentralization which fosters higher returns from information technology (we find IT is complementary with decentralization). Finally, we find that non-hierarchical religions and product market competition are also associated with more decentralization. Together these cultural, legal and economic factors account for four fifths of the cross-country variation in the decentralization of power within firms.

It seems then that trust is extremely important for economic development (and this is very old news). The questions are: Where does trust come from? And how individuals in a society can increase trust levels? Could we import or export trust? 

In the book Making Democracy Work (1994) Robert Putnam argues that northern Italy is more developed than the south because it had associations and clubs that created trust and social capital. And he indicates that the associations, clubs, etc., came from guilds that existed during the dark ages, and we don't know much beyond that . . . 

Interestingly it seems that trust comes from peace. Societies should look for peace first and trust will follow. Not surprisingly Adam Smith was right regarding the requirements for prosperity: rule of law, low taxes, and peace. He did not talk about trust but probably understood that peace is a prerequisite for it. 

Adam Smith’s Essentials

When trust is shaken, individuals pull back and the market system contracts. Where trust grows, individual energy and creativity are unleashed and the system grows. In Adam Smith’s vision of humankind’s progress, trust is the central theme. The Great Recession represents a classic case of a crisis of trust. Looking back to the work of Smith offers insight into the role of citizens and the State in creating an fruitful market environment based on trust, and the challenge of this process, given the human frailty of individuals (unfortunately, we are not angels) and the potential for State power to be captured and abused.

That is the abstract of the paper "Adam Smith’s Essentials: On Trust, Faith, and Free Markets" by Jerry M. Evensky.