Institutions Matter…But So Does Culture

Authored by David C. Rose via RealClear Wire,

In 1993 Douglass North won the Nobel Prize in Economics for his work in economic history. He stressed the importance of institutions—regularized patterns of behavior—for improving our understanding of how societies evolve and function. His main point was that high transaction costs choke off the economic activity that makes societies rich. Institutions are therefore vitally important because they help keep transaction costs low.

North’s insight helped revive institutional economics. Unfortunately many New Institutionalist economists viewed institutional theory as leaving little role for culture. Moreover, any role culture might play was subsumed in their paradigm as informal institutions. It is true that many cultural practices are informal institutions. But what if cultural beliefs can achieve outcomes that institutions can’t?

Suppose an individual from a poor country moves to a rich one and quickly starts to prosper. Most economists would argue that this happens because the rich country has better institutions.

But what if sudden uplift is just what happens when honest hardworking people from poor countries are dropped into high trust societies? In this case it’s trust, not institutions, that makes the difference.

This doesn’t mean that institutions are not important. Quite the opposite. Trust is so important because institutions are important, and many of them are highly trust-dependent. It’s not in every country that you would use an expensive coat to lay claim to a seat in a public place when you go to the rest room, for example.

David Landes, Deirdre McCloskey and Joel Mokyr have revived interest in the connection between culture and economic development. They argued that the beliefs and values of pre-industrial Europe set the stage for the rise of modern free market economies. In my latest book I explained why they would not have worked so well if they weren’t also culturally transmitted.

We don’t ponder whether to blink when dust blows into our eyes. We also don’t ponder whether to express sympathy to a friend upon hearing his mother died. Both involve behavior that is rather automatic, almost like it was encoded as an “if-then” statement in a computer program.

The first is baked in our genetic cake and is therefore a product of hardwired neural architecture, while the second is learned early in life and is therefore better described as a product of constructed neural architecture. At its core, culture is a mechanism for constructing a consistent neural architecture across individuals in a society to solve problems that are not well solved either by genetic encoding or consciously rational decision making.

If all behavior is consciously rational in the sense of Daniel Kahneman’s System 2 mode of thinking, then all individuals would always behave in a manner that was best for them and not the group. Game theorists would say they would “play defect” against rules created to support large group cooperation. This is a problem, because while we trust and therefore cooperate well in small groups, small group trust doesn’t scale up to work in the kind of large group contexts Adam Smith showed are necessary for the good life.

Smith didn’t think most behavior was consciously rational in the way modern economists think about behavior. He argued that our sensitivity to approval and disapproval provided a mechanism for forming consistent responses to circumstances. Smith’s perspective comports well with Kahneman’s conception of System 1 thinking, which is fast and intuitive, like holding a door for a stranger or leaving a coat to hold a seat. It’s pre-rational automaticity effectively circumvents rational analysis.

On the other end of the spectrum is genetic encoding. But if high trust societies were solely products of our genes, like honeycombs are for bees, then all human societies would be high trust societies. They aren’t because nearly all of our evolution took place in very small groups so there has been too little time to reinforce genes that support large group trust. Large group trust cannot be based on genetically encoded behavior. I submit that it can, however, be based culturally encoded behavior.

Some cultures convey moral beliefs that culturally encode the automatic rejection of untrustworthy actions. The earlier such beliefs are taught, the stronger they are reinforced, and the more they take precedence over other beliefs, the more likely behaving in an untrustworthy way isn’t even considered in adulthood.

When a critical mass of individuals abides by such beliefs, it becomes rational to presume most others can be trusted in most circumstances, producing a high trust society. Just as North would have predicted, by reducing transaction costs this makes cooperation through economic activity possible on a grand scale, unleashing human flourishing as never before. 

David C. Rose is a Professor Economics at the University of Missouri-St. Louis and a Senior Fellow at Common Sense Society. He is author of The Moral Foundation of Economic Behavior and Why Culture Matters Most, both from Oxford University Press.