Glorious revolutions and their discontents

N THE last two decades, economists have become increasingly interested in how institutions contribute to economic growth. They are particularly enthused by the view that institutions guaranteeing a “credible commitment” to liberal limits on state action—and repayment of the national debt—caused the industrial revolution to get off the ground in eighteenth-century England. This may at first appear to be an academic debate of only esoteric interest. But such views have quickly become dominant within economics. And some related conclusions—such as an emphasis on democracy and property rights as necessary pre-requisites for sustained economic growth—came to influence the so-called Washington consensus of global economic governance.

But some are now questioning whether this idea of “credible commitment” has been taken too far. The phrase itself may be one of the most over-used terms in modern economics. For example, a search on EconLit, an electronic bibliography of economics articles, finds no less than 1,932 hits for the exact phrase between 1976 and 2012. Of these, 1,894 were after Douglass North and Barry Weingast published a seminal paper in 1989. In this paper, Mr North and Mr Weingast argued that the growth in power of the English Parliament arising from England’s “Glorious Revolution” of 1688-89 created, for the first time, that “credible commitment” not to default on its debt in the future, and that this was a necessary prerequisite for the industrial revolution to occur.

Development economists have since leapt on this conclusion. Most prominently, the development economists Daron Acemoglu and James Robinson, argued in their book “Why Nations Fail” last year that political institutions account for the yawning gaps in economic performance around the world. If "inclusive" institutions—like those of eighteenth-century England—could be introduced into the developing world, rapid growth would follow. Much of the historical basis for the argument relies on Mr North and Mr Weingast’s view of the Glorious Revolution:

The Glorious Revolution limited the power of the king and the executive, and relocated to Parliament the power to determine economic institutions. At the same time, it opened up the political system to a broad cross section of society, who were able to exert considerable influence over the way the state functioned. The Glorious Revolution was the foundation for creating a pluralistic society, and it built on and accelerated a process of political centralisation. It created the world’s first set of inclusive political institutions… these foundations decisively changed incentives for people and impelled the engines of prosperity, paving the way for the Industrial Revolution.

However, a new book, edited by D’Maris Coffman, Adrian Leonard and Larry Neal, questions the historical validity of this argument. The essays they draw together argue that institutions in many cases became weaker, rather than stronger, after the Glorious Revolution. When King William III, a Dutchman, became King in 1689, English governments became more extractive and rent seeking—not less—in order to fund growing military engagements. The rising tax burden presented a challenge to property rights, and rent-seeking monopolies were allowed to grow in some sectors of the economy that had before been restrained under more absolutist governments. For example, as Mr Leonard explains, in 1720 parliament created a corporate duopoly in the marine insurance market—destroying many thriving firms in the process—as a form of revenue farming for the government. Other arbitrary decisions and legal absurdities continued right through the eighteenth century. In short, the surprising conclusion they reach is that the industrial revolution happened more in spite of poor institutions, than because of them.

The book suggests that many of the supposed benefits of political institutions were more properly the result of financial innovation. For example, the growth of efficient insurance markets reduced costs for business and trade. Merchants managed to side-step the corporate insurance duopoly by developing a system of individual underwriting (which was not regulated in the same way) to spread the risk of engaging in the shipping trade—a method still used today at Lloyds of London.

Gaining fiscal credibility appears to have been far more difficult and the processes more complex than Mssrs North and Weingeist have suggested. In terms of reducing risk, the development of secondary markets was far more important than innovations in primary ones. The growth of bond markets, for instance, reduced the risk of holding government debt by making its re-sale to other investors much easier. And changing ideas about honouring the national debt in the eighteenth-century Tory party (opponents of the new system of constitutional government introduced in 1689) were important in getting the new system to work. Without their change in attitudes, the shift to parliamentary rule would have meant little in practice.

In short, it seems that multiple mechanisms were needed to produce good institutions and sustain economic development in eighteenth-century England. We should not be surprised, then, when the sudden introduction of western-style political institutions to developing economies does not, on its own, create sustained economic growth.

Other great anomalies in economic history remain unanswered—such as why the economies of Russia and Eastern Europe imploded after the introduction of western-style political institutions in the 1990s, or why China has achieved such astonishing levels of economic growth over the last two decades with very little political reform. As an alternative, Ms Coffman and her co-authors’ argument—that “good” institutions are built upon multiple roots of legitimacy, with little reason to give the constitutional change a privileged position among them—appears to be much more convincing. So much the better that their conclusions appear to be backed up by meticulous historical research. Industrial England, it seems, was not built upon a melodramatic revolution of institutions, but on more boring, evolutionary processes.