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The fundamental problem exchange 53

related studies. Section 5 utilises these studies to argue that distinct institutions mitigating the FPOE may have distinct economic - efficiency and distribution - ramifications.2. Economic performance and the fundamental problem ofexchange

Ever since the days of Adam Smith, i t has been recognised that the abilityto exchange contributes greatly to economic efficiency. Exchange enablescapturing gains from distinct endowments, natural comparative advantage,and the division of labour which brings about prosperity in various ways,such as by specialisation, learning bydoing, and technological innovation see, for example, Rosenberg 1963, North 1981, Sokoloffand Khan 99Hence, one can conjecture that changes in the ability to exchange influenceeconomic performance over.time. enhanced ability.to exchange fostersprosperity while a l i ~ i t e ability t o d o so reeds stagnation.Economic theory places this conjecture at the centre of its framework: theFirst Welfare Theorem establishes that unlimited ability to exchange bringsabout Pareto-optimal allocations of resources, goods, and .services. Butacceptance of this conjecture is also implicit in economic history. Economichistorians often invoke increasing or diminishing ability to exchange toexplain historical episodes of economic expansion and stagnation. Centralto our account of how the W es t grew rich, for example, are periods ofexpanding exchange relationships: the late medieval commercial r e v o l u t i o ~ see, for example, Lopez 1976), the rise of the Atlantic economies Davis.1973), the commercial ascendency of the Dutch Republic and England, andthe nineteenth century growth of the international economy . Kenwood andLougheed 1999).Hence, much research in economic history has been devoted. to identifying th e extent and nature of exchange r e l t i ~ n s h i p s in various historicaleconomies.3 But this line of research naturally implies the importance.of thefollowing questions: What determines the e xte nt t o which m em be rs of asociety enter into technically feasible and mutually profitable exchange?The key to addressing this .question is to consider its inverse: Why woulddecision-makers not enter into mutually profitable exchange? A decisionm aker would not enter into an objectively mutually profitable exchangeunless assured that the exchange can indeed make him better off and thatthe other party would act in a manner that will make him better off. Forexample, a pote ntial l en de r f or a c ommer cia l e nde avour w ou ld no t lendunless he is ex ante convinced that the endeavour is as likely to succeed as3 For various contributions, see Galenson 1981, 1989), Aerts and Eichengreen 1990),Neal 1990), Hatton and Williamson 1991), Hoffman 1991, 1996), Rothenberg 1992 Buchinsky and Polak 1993), Rosenbloom, 1994).


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the borrower claims and that the borrower will ex-post be motivated to repaythe debt if the endeavour succeeds.4 In other words, a necessaiy conditionfor exchange is that ,one can ex-ante co mmit to being able and willing to. fulfil contractual obligations ex-post.The need for commitment reflects the essence of exchange as alwayssequential, namely, some time elapses between the quid and the quo Greif

1997a, p. 247-8). This sequentiality implies that it is possible for at least oneparty in the exchange to renege on his contractual obligations. Exchange issequential, for example, in credit relationships, implying that a debtor can,ex-post renege on his obligation to pay; in labour relationships, implyingt ha t one can, ex-post renege ona wage payment; in agency relationships,implying that agents can renege on their obligations; and in social relationships in which onegives affection, leaving a person vulnerable to rejection.The sequentiality of exchange implies the fundamental p ro ble m ofexchange FPOE): one will not enter into an objectively profitable exchangerelationship unless the other party can ex-ante commit to fulfil his contractual obligations ex-post.

The fundamental problem of exchange can be explicitly presented usingthe one-sided prisoner s dilemma game OSPD), also known as the game oftrust. In this game there are two individuals, one o f w h o m ~ n initiate beneficial exchange, but this case the other has the option of fulfilling his sideof the deal cooperating) or gaining even more by reneging. If renegingoccurs, the initiator of cooperation is worse off than if he had not initiated.cooperation.

In a game form: Player I can either initiate exchange or not. When hedoes not, both players ge t th ei r reservation payoff of o. If I initiatesexchange, however, player II can decide whether or not to also exchange,or cooperate by fulfilling his contractual ol?ligations Exchange is efficient,yielding a total payoff of that if player II exchanges) is allocated amongth e parties in a way that makes both of them better off than if they did notexchange. Player I gets - W and player II gets W o. But player IIcan gain even more, specifically ex > W, by reneging, leaving player I with4 One can be compensated for the risk associated with a particular exchange by getting alarger share in the ex-post expected gain. One would demand a higher interest rate toenter into a more risky loan. But unless the ex-post compensation is sufficiently large, OI ewould not enter into a risky exchange.S Clearly, transactions differ in the severity of this problem. Exchange relationships alsodiffer along additional dimensions - asymmetric information or the ease ofex-postverifiability of actions by a third.party. Similarly, some exchange relationships are ea.sierto embody in a larger exchange relationship - repetition, more than .one exchange, etc. than others. These differences among exchange relationships are important - the

attributes of an exchange determine the set of institutions that can potentially mitigatethe associated commitment problem. The importance of commitment problems has beenemphasised by Schelling I96o .


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Player I

Don t Exchange

Player

0,0Exchange-Cooperate

y-W W

a 0Figure I. One sided prisoner s dilemma game.

8 < 0 which makes hi m worse off than ha d he no t exchanged to beginwith.This game helps illustrate the essence of t he F PO E. C om mo n sense sug -gests that despite the inherent benefit of exchange, it will not take place. Ifplayer I initiates exchange, the best II cando ex post is to renege. Player I,ex ante anticipating this ex post be ha vio ur , will find it b es t not to initiateexchange to begin with. In th e jargon of gam e theory, the only sub-gam eperfect) equilibrium involves non-cooperation. In the absence of o m m t ~ .ment, exchange will no t take place.

The above game assumes, however, that t he benefit fr om exchange iscommon knowledge among th e interacting parties. In reality this is not.always th e case a nd to c apt ur e this we ca n extend the above OSPD of symmetric information to one of asymmetric information. Without loss of generality, assume that player I holds that there is only some probabili o/ thatth e exchange is indeed profitable that is, > as a ss ume d i n th e abovegame). Unless player I maintains with sufficiently high probability that th eexchange is profitable to h im t ha t is, - W > 0) , he will no t enter into. th eexchange even ifit is actually profitable. No w suppose that player II knowswhether or not the exchange is profitable. Player I,.ho.wever, c annot trustplayer II to reveal the true probabili ty of profitability whenever player IIstands .to gain from misleading player I. In other words, in this extendedgam e there m ay be no equilibrium in which player II s statement a bout thesituation influences player I s assessment of it. In this case, to induce playerI to enter into a mutually profitable exchange which he, nevertheless doesno t perceive as such), playerII ha s t o be able to lend credibility to his claimregarding the exchange s profitability.

Th e extent to which me mber s of a society will e nte r into exchange

.


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56 European Review Economic History

relationships and hence the extent to which society will reap the benefitsfrom them depends on thedegree to which the FPOE mitigated in various transactions. The ability to benefitfrom exchange determined by theability to mitigate the associated fundamental commitment problem.

3. A research agenda: the role and nature of institutionsInstitutions can and do mitigate the FPOE by fostering the ability ofdecision-makers to ex ante commit to respect their contractual obligationsex post and to reveal their ability to do so. They foster the ability to commitby linking past conduct with future reward thereby reducing the benefit ofmisrepresenting information and reneging. To understand the extent of theexchange relationships into which decision-makers entered in a particularhistorical episode therefore necessitates studying the institutions that mitigated the FPOE in that time and place. 6Studying institutions that mitigate the FPOE with respect to a particulartransaction requires us to examine how beliefs regarding the relationshipsbetween past conduct and future utility stream are created in that particular historical episode. This requires identifying the exact nature of the sanctions which would be imposed following a breach of contract how theappropriate information is o btained and disseminated who applies thesanctions how the.sanctioners learn or decide what sanctions to apply whythey do shirk from their duty and why the offenders do not flee to avoidsanctions.Multiple institutions can usually govern a particular exchange. impartial and effective legal system based on the coercive power of the state canpunish a person who has reneged and increase the cost of misrepresentingability and information. If the parties to the exchange believe that legal sanctions will prevail player II will find it optimal to fulfil his. contractual obligations and player I will believe that he will do so. Player I will then initiatethe exchange. But private-order institutions that do not rely on legal sanctionscan also enable exchange. Such institutions can be based for exampleon beliefs in social sanctions and the loss of economic reputation and futurebusiness because of bad past conduct. If the sanctions following renegingthat such institutions imply are sufficiently high relative to the gains fromdoing so exchange will take place.

The observation that sanctions other than legal sanctions can supportexchange suggests the need to examine institutions while going beyondidentifying them with legal rules specified and enforced b y the state. The6 For simplicity of exposition the discussion emphasises the importance of enabling

decision-makers to enter into exchange relationships and ignores the fact that preventingdecision-makers from entering into various exchange relationships often sociallybeneficial: e.g. Wright 20.00 .


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view of institutions as legal rules is common in economic history f o l l o w i n ~North and Thomas 1973) an d North 1990), an d it is complemented b y th eview of organisations as groups of individuals who together pursue_th eobjective of changing such rules. This view is no t adopted here-because it istoo restrictive for discussing the situations this work is concerned with, in.which enforcement is endogenous. In such situations we cannot assumethat people will follow rules because they are enforced by anon strategicimpartial legal system. All behaviour has to be endogenously accounted for.Accordingly, economic institutions are defined here as a system of socialfactors - such as rules, beliefs, norms, an d organisations - that guide,enable; an d constrain the actions of individuals, thereby generating regularities of behaviour. When enforcement is endogenous, such a-system an d th eassociated behaviour have to be self-enforcing.7 That is, the- -actual an dexpected behaviour of ea ch individual leads other s to behave a nd toe xp ec te d t o behave i n a manner motivating each individual to s s ~ m e t h i sexpected behaviour to begin with. In other words, roughly ,speaking, thesocial factors that influence one s e h v i o u ~ lead one to behave in a way thatmotivates others to behave in a manner causing these social factors to pre,vail. Th e structure that each individual faces induces him to take the actionsthat, on the aggregate level, create this _structure.

Each soc ia l factor - rules, beliefs, n or ms , an d organisations ha s aspecific role in the functioning of self-enforcing institlitions that link pastconduct an d future reward. Rules guide and -coordinate behaviour whilebeliefs an d norms motivate individuals to follow them._Organisations either formal ones such as parliaments an d th e courts, or informal ones such ,as communities and business networks - produce or influence the production of rules, harbour rules and make them known, contribute to the p e r ~petuation of norms, an d influence th e set of beliefs that can prevail .regarding a particular transaction.

To understand how organisations accomplish such tasks, we have toexamine th e motivation their me mbe rs face. To u nd er st an d why, forexample, a credit bureau provides reliable information or why courts andth e police enforce ,rules, one must examine the, motivation of the decisionmakers within-them. Note tha t in this framework, political and legal organisations, such as parliament-and the courts, have a similar function aIidhaveto be examined in a way that is comparable to other. organisations, such asa credit bureau. Their actions - particularly their ability to initiate th e useof coercive po we r - may be different from that available to other organis-ations, but the difference lies in the details a nd n ot the essence.The. above conceptualisation of institutions is a generalisation of :he onecommonly used and it enables extending th e analysis beyond the confines of7 F or additional conditions on such a system becoming an institution,_ see Greif forthcoming).

\t


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Studying institutions that mitigated the FPOE in v r i o u ~ times and placespresents a methodological problem because institutions can be idiosyncratic. This limits the ability to use the statistical tools that are a hallmarkofmodem economic history. Furthermore, examining institutions does no tlend itself to statistical analysis because the effectiveness of contractenforcement institutions is usually best judged like that of peacetime armies- by how little they must be used. Thus in reading the historical records todetermine whether a major role of a particular institution was to ensure contract compliance, the number of instances of enforcement not a usefulindicator. An institution that effectively mitigates the ,fundamental problemof exchange implies, at the limit, that all contractual obligations will be fulfilled. Similarly, the implications of institutional and organisational featuresthat match parties to exchange and provide information are often no tdirectly observable.These difficulties are among the reasons why, until recently, i n s ~ i t u t i o n lanalysis concentrated on legal rules. But the above discussion suggests that

FPOE can be mitigated, based on institutions which do not depend on thelegal system. Even in modem economies private-order institutions mitigatethe FPOE reflecting the limited effectiveness of legal, institutions (GreifI997a). Information costs, the difficulty of verifying past actions, the i n i ~ -ityto write comprehensive contracts, and the boundaries of the state s jurisdictional power limit the state s ability to support exchange. Arguably, thesedeficiencies of the legal system, and hence the prevalence.of private-orderinstitutions, were even more pronounced in past economies.

Our ability to study private-order, legal institutions, and their hybrid,forms has been recently enhanced by developments in microeconomictheory such as game theory, contract theory, and informational,economics.These developments make it possible to analytically study t h e n o n o s e r v ~able aspects of institutions (such as beliefs) while generating predictionsthat can be refuted by the data. Theory now en ables us to study unobservable institutional elements while upholding the long scientific t r d ~ t i o n ofeconomics: testing hypotheses and producing arguments that can be falsified by the data. At the same time, these theoretical frameworks lend support to the assertion that institutional analysis is inherently historical. Theyindicate that the set of institutions leading to a particular outcome is verysensitive to the details of the historical context and multiple institutions canprevail in a given situation., Studying institutions using these theoretical frameworks thus requires an ,interactive approach in which historical and theoretical analyses are combined. Historical analysis required to reveal the details of the situation,generate hypotheses regarding relevant institutions, highlight the process ofinstitutional selection, and provide the evidence required to evaluate theoretical predictions. At the same time, theory is needed to substant iate orrefute various hypotheses by evaluating the logical consistency of the ,argu-


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6 uropean Review ofconomic istory

ment, revealing lines of causation, generating predications, and. indicatingan institution s implications.The scope of this essay does not permit a detailed presentation of this.interactive approach - Historical Institutional Analysis. Nor does it permitfurther general elaboration on how institutions mitigate the FPOE. Hence,I.will only briefly present historical analyses which further support the claim

regarding the benefit and possibility of studying institutions that mitigatethe FPOE.4. Historical institutional analysis of institutions thatmitigate the FPOE

The examples I will provide draw onmy research on the Late or High)Medieval C.ommercial .Revolution, the developmental epoch stretchingfrom the eleventh to the fourteenth centuries. Concentrating on institutions.that mitigated the FPOE at this time and place seems appropriateseveral reasons. This period witnessed the re-emergence of Mediterraneanand E ur op ea n long-distance t ra de after a n ext ended pe ri od of declinedespite the absence of appropriate legal enforcement provided by the state.Furthermore, this commercial expansion is considered a turning point theeconomic .history of Europe. Institutional development during it had a lasting impact on later European development Reynolds, 1952 while Western.wealthbegan with th e growth of European trade and commerce whichstarted in the twelfth century in Italy Rosenberg and Birdzell, 1986, p. 35).Needless to say, the following discussion has to be short and incompleteand the reader can further consult the papers on which it based. 10 In particular, the discussion does not present the explicit models used in thesestudies. These models permit going beyond narrative institutional historyby making arguments exact, revealing lines of causality, generating predictions that c an b e confronte d wi th the evidence, and enabling inter-institutionalcomparison. My hope is that the discussion will, nevertheless,illustrate the ability to conduct a comparative analysis of private-order his-, torical institutions and will lend credibility to the assertion that we should

x ~ m n the long-run efficiency implications of distinct institutions. Institutions that governed the relations between rulers n alienmerchants

Since the political units during the late medieval period were relativelysmall, spatial specialisation in production required trade across political See references in fns 2 and 3.

10 See in particular Greif 1989, 1994a, b 1996) and Greif et ale 1994). The discussion this section draws heavily on a similar summary presented Greif 1998b).


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The fundamental proble l ( .\ ( 11(/1/.1: 2 I

boundaries. Bu t a difficulty arose: any medieval ruler the tC111ptatiullto ab us e th e persons and-property of alien merchants who frequented hi srealm, having a local monopoly over coercive power. Without an institutionthat enabled the r uler to- commit ex ante to secure their rights, alien merchants were no t likely to frequent that ruler s territory, thereby depriving itspopulation, the ruler _ and the merchants of th e benefits of trade. Th erelation between,the expected security of property rights and trade expansion was clear to the English King, Edward I, who in 1283 remarked,Many merchants [fearing lack of protection] are pu t off from coming,this l an d wi th th ei r merchandise to th e detriment of merchants and ofthe whole kingdom English Historical Documents 1975, p. 420 .Since trade relationships,were expected to repeat, one may conjecturethat a self-enforcing institution employing a bilateral reputation mechanism in which the ruler is deterred from abusing, expecting that a mer chantwhose rights were abused would cease trading), or employing an u n o o r d i ~nated multilateral reputation mechanism in which a larger subgroup thanth e abus ed one would cease trading), could surmount this commitmentproblem. Since these mechanisms create an ex ante linkage between, pastconduct and the futur e income str eam, a ruler who highly _valued futureincome can credibly commit himself ex ante no t to abuse merchants -rightsex post.

To examine these hypotheses, Greifet l 1994) modelled this situation, as a game, taking into account that a ruler s gain from taxation of theginal trader declines when trade volume increases. The analysis indicatesthat although each of t he above mech ani sms c an s up po rt some level of,trade, neither can support the efficient level o tr de no matter how the gainsfrom trade are divided among the merchants an d the ruler, no r how patientthe ruler). Th e bilateral reputation mechanism fails because, at the efficient,level of trade, the value of the f utur e trade of the marginal traders to theruler is zero, an d hence the ruler is tempted to abuse their rights. In a worldfraught with information asymmetries, slow communication, an d p l ~ u s i l ydifferent interpretations of facts, the multilateral reputation mechanism isprone to fail for a ,similar reason.Theoretically, to overcome the-ruler s commitment problem at the efficient level of trade, an organisation that coordinates traders responses isneeded. When coordination is achieved, th e thr eat by all the merchants tocease trading if ny merchant is abused enables th e ruler to commit -- giventhat the merchants threat of retaliation is credible. Unfortunately, however;the thr eat is no t credible because it entails a complete boycott where tradewould shrink below the level at which, for example, a bilateral rep,utationmechanism is effective. Hence some traders would renegotiate with theruler to resume trading and impede th e cootdinating organisation s abilityto surmount the commitment problem by reducing the penalty threatenedto be imposed on the ruler.


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262 European Review ofEconomic History

The need to take special measures to prevent shipments to an embargoedcity, are confirmed by the historical evidence. For example; in 1284 aGerman trading ship was attacked and pillaged by the Norwegians. TheGerman towns responded by imposing an embargo on Norway. The expor-tation of grain, flour, vegetables and beer was prohibited. According to thechronicler Detmar, there broke out a famine so great that (the Norwegians)were forced to make atonement . The temptation for an individual merchant to smuggle food to Norway in this situation is clear. To sustain theembargo, the German towns had to post ships in the Danish Straits. I ISimilarly in 1358 the German towns imposed an embargo on Bruges andthe city attempted to defeat it by offering merchants from Cologne extensive trade privileges.12

Thus to support the efficient level of trade, an organisation with theability to coordinate responses n to ensure the traders compliance withboycott decisions is needed to supplement,a multilateral reputation mechanism. The traders must have some mechanism thatmakes the threat ofcollective action credible. The formal analysis thus supports De Roover s(1965) conjecture that the role of the merchants formal organisation was,ofcourse, to provide,collective protection in foreign lands, to secure tradeprivileges, if possible, and to watch over th e strict observance of thosealready in effect (p. I I IHistorical evidence indicates that. during the late medieval period aninstitution with these attributes - the merchant guild - emerged and sup-,ported trade expansion and market integration. I3 Merchant gUilds exhibiteda range of organisational forms - from a subdivision of a city administrationlike the Italian city-states, to an inter-city organisation such as the GermanHansa. Yet their functions were the same: to ensure the coordination andinternal enforcement required to s u s t ~ n credibility of the beliefs in col-lective action. These organisations, the associated beliefs, and the rules thatcoordinated expectations on what actions by the ruler would be consideredtransgressions, were the social factors that together constituted the institution that govemedthe relationships among rulers and merchants.

For example, a merchant guild s strategy of conditioning future trade onadequate past protection, the use of ostracism to achieve security (ratherthan privileges or low prices), and the relationship among those acquiringinformation, coordination, and the ability to boycott, are reflected in theagreement made in 1261 between the Flemish merchants from Ghent, Dollinger (1970), p. 49. See also his description of the embargo on Novgorod p.48).Anyone who broke the embargo was to suffer the death penalty and the confiscation ofhis goods.12 Dollinger (1970), pp. 65-6. 3 This discussion relates to merchant guilds and not craft guilds. Furthermore, not only isthe definition of merchant guilds here much wider than is customary, bu t no claim ismade that the above was the only function of guilds.


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Ypres, Douai, Cambrai, an d Dixmude who purchased English wool. F orthe good of the trade , they decided t ha t i f it should happen. that any clericor an y other merchant anywhere i n E ng la nd w ho deals with sales of wooldeals falsely.with any merchant in this alliance , by giving false weight orfalse dressing of th e wool or- a false product, . . . and if they do no t wish tomake amends, w e h av e d ec id ed th at no present or future memberof thisalliance will be so bold as to trade with them Moore 1985,P. 301). Tom ak e this threat of boycott functional, they decided that there will be ineach of these cities one ma n to view an d judge th e grievances, and to persuade th e wrongdoers to make amends ibid.).

Flemish regulations from 1240 illustrate recognition of th e need t o pro vide all traders with an incentive to support a boycott. A merchant whoignored th e ba n imposed by the guild on a no th er t ow n was expelled,losin g h is rent stream. I f any ma n of Ypres or Douaishall go again sttho se d ecisio ns [made by th e guild] for t he c om mo n .good, t;egardingfines or anything else, that m an shall be excluded from selling, lodging,eating, or d ep ositin g h is wool or cloth ships w it h t he rest of t he m er chants. And if any on e violates this o stracism , he shall be fined 58

ibid. , p . 298).The G e rm a n R an sa is p erhaps on e of the. best examples t f an institution that fostered trade expansion by limiting, in a self-enforcing manner,th e rulers ability to predate. For historical reasons, membership in th e .basic organisational unit that coordinated the activities of G er ma n m er chants abroad - th e ontorwas no t conditional on residency in o ne particular twn. An y German merchant wh o arrived in anon-German citycould join th e local ontor A ontorha d th e same function as th e guild incoordinating th e responses of th e German merchants in disputes with th.etown. It lacked th e capacity t o p un is h merchants in th e townswhere theyr es id ed , ho we ve r, w ea ke ni ng its ability to enforce sanctions. again st itsmembers.

In 1252 a ontorof German merchants obtained extensive tradin.g privileges f ro m t he city of Bruges Flanders), which was t he m ai n trading centreof northern Europe at that time. The ontorwas le d b.y six aldermen electe d by th e G er ma n merchants present in the town - two from each regionof Germany. 14 Despite promises t o t he contrary, the property rights of alienmerchants in Bruges were continually abused. The situation is described ina document dated 1280,. reporting that i t is u nfortu nately on ly to o wellknown that merchants travelling in Flanders have b ee n th e objects of ali .kinds of maltreatm ent in the town of Bruges an d have no t been able to protect themselves from this Dollinger 1970, p. 383).

An embargo imposed by all alien merchants on Bruges from 1280 to 1282secured th e property rights of th e Italian an d Spanish traders, bu t failed to14 Weiner 1932), p. 218; De Roover 1965), p. 114; Dollinger 1970), p. 86.


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secure the German traders rights. This failure was due to different mechanisms for contract enforceability available to the German arid the othertraders. The relatively large and well-organised political units of the Italianand Spanish merchants provided them with a state-backed mechanism tosupplement the self-enforcing relations. between them and Bruges, bymaking their threat of future trade.embargoes credible. In contrast, becausethe Kontor encompassed only the German merchants actually present inBruges, rather than all the potential German traders who might want totrade during a boycott, its threat of sanctions against Bruges was not credible. IsAnother embargo by the German merchants from 1307 to 1309 wasrequired to force Bruges to respect their property rights. Its successful conclusion enabled the commerce between Flanders and Germany to flourishand expand for the next 50 years (Dollinger 1970, p. 51). What had changedbetween 1280 and 1307 was the ability of the German towns to coordinatetheir responses and enforce their embargo decisions on each other. Amilestone occurred in 1284 when the Wendish German towns imposed anembargo on Norway. Merchants from the city of Bremen refused to cooperate in the embargo, and the other German towns excluded Bremen s merchants from all German Kontore The German towns had achieved thecoordination needed to exclude one of their members from the economicrent generated by their common activities. The ability to exclude, in tumwas used to make their. decisions self-enforcing. It is important to note,however, that this self-enforceability was used to motivate each town toemploy its authority as apolitical unit. to ensure that its merchants wouldnot break the embargo. To sustain the embargo of 1284, for example, theGerman towns posted ships in the Danish Straits to prevent any Germanmerchant from smuggling goods to Norway (Dollinger 1970, p. 49).

The importance of the German towns coercive power over their merchants in strengthening the operation of a multilateral reputation mechanism that governed the relations between these merchants and Bruges isapparent when these relations came under strain. The war between Englandand France around the middle of the fourteenth century increased the costto Bruges of securing the German traders property and lives. Increasing thelevel of protection required the Hansa to enhance its ability to impose atrade embargo on Bruges and to demonstrate this ability. In 1356 theGerman Hansa held its first Diet (assembly of representatives from all theHansa s towns), and its authority over the Kontor of Bruges was declared.As the prominent historian of the Hansa, F. Dollinger, has noticed, [I]nlaw, and not only in fact, the towns, acting through the general Diet, were

5 Regarding the embargo of 1280 and its (partial) failure, see Dollinger (1970), pp. 48-51.16 Dollinger (1970), p. 49; Weiner (1932), p. 219.


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The fundamental problem ofexchange 265

~ l h l i s h i n g their authority over their merchants in foreign ports Dollingert ~ J 7 p. 69 .

l h cI?-hanced ability of political units to exercise their coercive power{ n ~ l r their merchants fostered the operation of the self-enforcing institutiontl1:t t governed the relations between these merchants and another politicalunit, the city of Bruges. In the Hanseatic embargo against Brugesin 1358, \vas announced that any disobedience, whether by a town or an individt 1aI was to be punished by per petual exclusion f rom the Hansa.Brugesat tl 111pted to defeat the embargo by offering trade privileges to individuali lies including both non-Hanseatic ones like Kampen, and a Hanseaticl}JlL Cologne. The non-Hanseatic cities accepted Bruges s terms, but :ologne refused to cooperate. The embargo proved a success and, in 1360,I\ruges came to terms with the Hansa. I7.rhe institution of the German Hansa was now fully formed. It governedthe re lat io ns b et wee n G er ma n merchan ts, t hei r various towns, a nd t het )reign towns with which they traded. It was based on a combination of selfenforcing and state-enforced mechanisms that, at least for awhile, advancedexchange. The Ransa s leadership coordinated and enforced cooperationhetween German merchants and towns, one that served at least for somet ilne - the interests of all sides.

4 Institutions that governed the relations between merchants noverseas agents

l)uring the late medieval period mar ket expansion and integration werefacilitated by the employment of overseas agents who enabled merchants toreduce the cost of long-distance trade by saving the time and risk of travel :ling, diversifying sales, and so forth. The contribution of agency relations to .reduce the cost of trade and hence to foster market integration has been recognized in the context of many premodern trading systems.I8 For agencyrelations to promote efficiency, however, overseas agents had to h a v ~ control over a merchant s capital abroad, enabling them to act opportunisticallyand expropriate that capital. Hence in t he absence of.an institution thatlimited opportunism, merchants would not hire agents. Indeed, Cipolla haspointed out that the contractual problem associated with agency relationscould not be resolved by the legal system or the anonymous market. Ana ge nt who t ra de d using so meone else s capital c ou ld easily have disappeared with the capital or cheated in business conducted in far-off markets .where none of his associates had any control Cipolla 1980, p. 198).17 Dollinger 1970), p. 66. For further details of this embargo, see pollinger 1970), pp.

63-6, and Weiner 1932), p. 220.18 See for example, Lopez and Raymond 1955), p. 174;De Roover 1965), pp. 43, 45ff,70ff; Postan 1973), pp. 66ff.


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What were th e institutions that governed agency relationships during th elate medieval period? The institution that governed agency relations amongthe Maghribi traders who operated in th e Muslim Mediterranean during th eeleventh century has recently been examined (Greif 1989, 1993). TheMaghribis were the descendants of Jewish traders who during. the tenth century ha d left the increasingly politically insecure surroundings of Baghdaan d emigrated to North Mrica. By th e .eleventh century the Maghribitraded all aroundthe Mediterranean. I9

Game theoretical and historical analysis suggests that agency relationamong the Maghribis were governed by an economic institution t ha t c an breferred to as a coalition - a non-anonymous institution based on a multilateral reputation mechanism. The organisational feature that at the same timm ad e t he coalition possible an d reflected its operation, was the Maghribtraders group. This group enabled beliefs in collective punishment to prevail an d it harboured. an d produced th e information an d rules required foth e functioning of the coalition.

The Maghribis employed each other as agents, an d they allexpe.cted thamerchants would hire only group members as agents, a nd t ha t all of themwould cease employing an individual who ha d cheated a coalition memberTheir social an d commercial network provided the information required todetect an d announce cheating, an d th e multilateral punishment was selfenforcing since what kept an agent honest in his dealings with a specifimerchant was the fear of losing the rent stream available to hi m from hifuture dealings with all the Maghribis. Hence, if i t was expected thatspecific agent would no t be hired i n t he future, he did no t s tand t o lose thvalue of future relations with th e Maghribis if he was caught cheatingTherefore, to such an agent honest, a Maghribi merchant ha d t o p rovide hi m with a rent much higher than the one that would have kept a.alternative. agent honest. The merchant ha d to pay this unusually high renin order to make the future value of their relations high enough to inducth e agent to be .honest in the absence of collective punishment. Since thaimplied a reduction in the merchant s own profit, each merchant wainduced to hire only agents who were expected to be hired by others, an.th e collective punishment became self-enforcing.Multilateral punishment-within th e group enhanced efficiency an d profitability relative to bilateral punishment (in which only the trader who wacheated retaliates), since it enabled th e employment of agents even wheth e relationship between a specific m er ch an t a nd agent pair were no

9 Fo r a general introduction to the Maghribi traders and the geniza documents that reflectheir trade, see Goitein (1967), Introduction; an d the entry Geniza in Houtsma (1978)vol. 3, pp. 987-9

Du e to space limitation the following discussion does no t present the related rules. Fo rthe ir discussion, see Greif (1993).


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l xpccted to recur. The resulting additional gains from


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was established. A partnership brought together two or more parties whinvested capital and labour , though not necessarily in equal shares. Thessence of a formal,friendship relationship was that two traders operated idiffer ent trade centres, providing each other with trade services in therespective centres. Neither received pecuniar y compensation. Thiexchange of services was not based on emotions, nor was it a reciprocaexchange; ra th er it was purely a business matt er. The relationship wainitiated by an agreement and could be terminated by either party at antime. As l on g as th e relationship was in force, however, each party.wabound to provide his formal friend with trade services. A factor providetrade-related services.to an absentee trader, probably for a commission.23Yet the Maghribi traders mainly used partnerships, friendships, anfactor relations.24 In literally every business letter they are mentioned, whilcommenda relations are har d to find. In twelfth-century Italy the situatiowas. different; agency relations mainly took the form of a commenda Howcan this difference be explained? Why d id t he Maghribiand Italian traderwho were familiar with the same forms of business association, ~ t i l i s e diferent forms?

Furthermore, agency relations among the Maghribis were characteriseby flexibility. Sedentary traders served.as agents for those :who travelled, anvice v e r ~ Wealthy merchants served as agents for poorer ones, and vicversa Usuallya trader .served as an agent for several merchants, whireceiving. agency services from them or other traders.26 This flexibilistands in sharp contrast to practices in twelfth-century Italy. Italian tradealso adopted commendas and established partnerships. More often than.nohowever, commenda relations were established between wealthy merchanand ambitious young travelling traders, while partnerships were establishemainly to organise common ownership agency relations within a famil. firm. 27 Why d id Maghribi traders serve as agents and merchants simutaneously? Why were agency relations so flexible?

To comprehend this observation one has to note that among thMaghribis it was expected that i fan agent wp o had cheated employed otheMaghribis as agents, they were free to cheat him without being punished.These expectations are reflected in a document dated 141/42. In this lettea trader from Fustat accused his Tunisian agent of having failed to remit threvenues from a certain sale. As a result of the accusation, so the agent complained, the peoplebecame agitated and hostile to [me] and whoeve r owe

Fo r additional discussion, see Greif 1989).24 Goitein 1970); Goitein 1973), pp. IIff.; Gil 1983b), vol. I pp. 216ff.S See for example, De Roover 1965).26 See, for example, the business relations described in Michael 1965), Stillman 1970).27 Lane 1944), pp. 178 ff; Sombart 1953), pp. 31ff; Lopez and. Raymond 1955), pp. 174185-86; De Roover 1965), pp. 5Iff.


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he fund ment l problem exch nge 69

l1HH1CyJ conspired to keep it from [me] .28.If such e x p ~ t t i o n s prevailwnh l a coalition they create a capital premium; they increase the returns

a tlll I11ber merchant s capital since it reduces the wage that a merchantttl pay his agent to keep him honest. Thus.a member merchant will hire. }other Inember merchant as his agent. The wage that has to be paid to .~ H h h a I11erchant-agentis lower than the wage that has to be paid to a traderW ht l acts only as an agent, since when considering cheating, the merchant\lt cnt \vill take i nt o a cc ount the fact t ha t h e will also lose t he capital pren n available to him. His own member agents will cheat him, andilft:ording to the implicit contract within the coalition, they will not be punItlhcd. 2 l

I his theoretical observation leads to a testable prediction and is a key i nfxplaining the above phenomena. Since the. implicit contract within thei ~ n l i t i o n creates a capital premium, merchants prefer to utilise other mer-.thann; as their agents. This preference may be reflected in the forms,chosen H business association; agency relations ~ i l l be organised through formsthat require agents investments. Indeed, the common denominator of theIt lrlllS of business association utilised by the Maghribi traders is that bothparties invested in trade. In Italy, one may conjecture, agency relations wereflt t organised within a coalition and thus a merchant preferred to. employan individual as his agent whose income from his alternative occupation wasth e lowest. Thus merchants utilised agents through commend relations. 30 .Organising agency relations within the coalition and the motivation itprovided for merchants to hire other merchants as their agents, also explains.\vhy t r d e ~ s served as both agents and merchants simultaneously and whyagency relations were as flexible as they were. More generally, the reliance.t)n capital premium determined the social characterisations of the Maghribitraders group. One does not observe the existence of two separate classesaniong them - an agents class and a merchants class. Socially, theMaghribi traders group was a homogenous group of middle-class traders,l ach operating as both a merchant and an agent at the same time.Besides traders from the Muslim world, Italian traders were very active inMediterranean trade after the eleventh century Institutions that governedagency relations also emerged among them, although a different political,social, and cultural history seems to have led to the emergence of a different institution - the patron system - based on bilateral reputation and state Bodl. MS Reb a2 f. 17; Sect. D Goitein 1973), p. 1 429 An agent-merchant may avoid these losses by employing a non-member agent. Thisrequires a larger premium, however, and implies a reduction in the value of themerchant s capital.30 The cost of an honest agent is lower, the lower his income from his alternative

occupation his reservation utility) Italian merchants preferred to hire s:gentswithout capital, and therefore they could not utilise friendships and partnerships inagency relations.

, .


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7 uropean Review ofconomic istory

enforcement (Greif 1994a). n other words, among the Genoese an agenwas induced to be honest by the fear that, if he was not, his relations with aparticular merchant (who could have represented a family or even a clan)would be terminated. Furthermore, the legal system contributed to inducing honesty by providing contract registration facilities in many trade centres, specifying a minimum rate of return in case accounts were nofurnished, and holding an agent s proper ty and family hostage until theagent s return (Lattes 1939, pp. 77, 154).

The nature of the historical sources available for Genoa provide onlyindirect evidence regarding the operation of the patron system. Among thetheoretical observations underpinning, the evidence is that, when agencyrelations are governed by the patron system, the wage that has to be paid toan agent to induce honesty declines with the agent s most profitable alternative. Since this alternative is likely to increase with the agent s capital, undethe bilateral. reputation mechanism merchants are not likely to hire othemerchants as their agents.3 n other words, when agency relations aregoverned by the patron system we are likely to see a merchants class and anagents class . Note that this prediction contrasts sharply with, the situationwhen agency relations are governed by a coalition inducing merchants tohire other merchants as their agents.Indeed, the historical records indicate that classes and inflexibility inagency relations prevailed in Genoa but no t among the Maghribis. The dif, ference in the social structures of the two groups can be assessed using anagency measure , defined as the number of times a trader operated as anagent divided by the number of times a trader operated as either a merchanor an agent. t equals one ifthe trader was only an agent, zero if he was onlya merchant, and some intermediate value in between if he was both a merchant and an agent. n 75 letters written by Maghribi traders in which 652agency relations are reflected, 9 traders appear more than once, .andalmost 70 per cent of them have an agency measure between zero and oneFurthermore, the more a trader appears in the documents, the more likelyhe is to have such an agency measure.32

n contrast, agency measures ,calculated from various cartularies reflecthis assertion. o r example, only per cent of the 190 trader families mentioned more than once in the cartulary of Giovanni Scriba (1155-1164[ 935] have an agency measure between zero and one, and in value termonly per cent have this agency measure.33 All the others were ,either merchants or agents, but not both. This finding is in accordance with th3 Yet the merchant would want to employ an agent With wealth that could be confiscatedby the legal system, in case the agent embezzled the capital outright.32 The nature of the sources precludes calculating a value-based agency measure for the

Maghribis. See Greif (1994a).33 Krueger (1957) concluded that only 6 per cent (36 traders) in Giovanni Scribafunctioned as both agents and merchants.


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European Review ofEconomic History

honest agent will be rehired, and the lower the probability that a cheater willbe rehired, the lower the wage that a merchant has to pay his agent. Withina coalition this wage reduction is achieved by collective punishment - hon-esty in relations with one merchant.implies a high likelihood of being hiredby another merchant, while cheating one merchant leads to termination ofagency relations with all merchants. When agency relations are governed bythe patron system, however, this is not the case and eachmerchant is motivated to reduce the wage by credibly signalling that he will operate throughan agent for many periods.This theoretical prediction reveals the rationale for distinct organisationaldevelopments among the Maghribis and the Genoese. When members ofthese groups first began trading in the Mediterranean, it was common for atrader s son to start operating independently during his father s lifetime.The father would typically help the son until he was able to operate on hisown, and after the fath er s death his estate was divided among his heirs andhis business dissolved.37 Later developments of business organisation andfamily. relations however, differed substantially. During the thirtee.nth century the Genoese traders adopted the family firm, the essence of which wasa pe rmanent partnership with unlimited and joint liability. In many casesthis organisation preserved the family wealth undivided under one ownership, and a trader s son, reaching the appropriate age, joined his family sfirm.38 The Maghribi traders, after being active in trade at least as long asthe Genoese, did not establish a similar organisation. The rationale for thisuneven development is clear, however,. when realising .that a Genoese andnot a Maghribi merchant was motivated to credibly signal that he wouldoperate through an agent for many periods. This signalling was achieved byestablishing a ~ m i l y firm whose lifespan was infinite , .and which.was lesslikely to go bankrupt than a single m e r c h ~ t

s Institutions institutional efficiency and distinctinstitutional trajectoriesExamining the institutions that mitigated the FPOE in a particular historical episodewould enhance our understanding of social outcomes only if distinct institutions have different implications. If institutions are alwaysoptimal, enabling exhaustion of all feasible. gains from exchange given theavailable technology, their study is of secondary importance. The significance of institutional analysis lies in the assertion that different institutions37 Regarding the Maghribis, see Goitein .(1967), pp. 180ff; Gil (1983b), vol. pp. 21SffRegarding the Genoese, see, for example, Giovanni Scriba 236, 575, 1047 for a father s

help and 946 for a will.38 See discussion in De Roover (1965), PP 70 ff; Rosenberg and Birdzell (1986), pp.123-4.


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The fundamental problem o exchange 273

hnvc distinct economic, social, and politicalramifications and t h ~ t pasthlst it utions direct the process of institutional change.

I heabove discussion of institutions Iduring the Commercial Revolutionf upports t he claim that this is in de ed t he case. These institutions were

n l c i ~ n c y enhancing. Yet examination of the processes that moulded t ~ m nd their n at ur e suggests the y were no t merely a r es po ns e t o economicneeds. These institutions reflected social, political, and cultural p r o s s ~of\vhich they were an integral part and their interrelationships with thesepn ) c ~ s s e s imply that they were not optima1. 9

li or example, the timing of the emergence of a merchant guild in variouslocalities, and the resulting trade expansion, was determined by social andJHllitical factors. The major Italian city states grew large because of the~ l c i a l political, and economic events around the Mediterranean. Italiantrade expanded because each city functioned as a merchant guild, and itsS l Z ~ implied that its t ra de rs were not marginal . Although the. potentialgains from trade in the Baltic Sea were sub,stantial as well, that region s set-tll Il1ent process led to small towns that could no t assure the safety of theirtraders abroad. Only a fter a long process of institutional evolution werethese towns incorporated into an inter-city. merchant guild, the GermanIlansa,. that led Baltic trade to. prosper. Similarly, the institutions that governed agency relations - the Maghribis)alition and the Genoese patron system - also reflect social, political, and.cultural processes. These processes determined the .nature of the institutions and the timing of their emergence and disappearance. Particularly, the )rigin and extent of the Maghribis coalition seems to have been a by-prod- .lJct of the immigration of the Maghribis to North Mrica and their culturalattributes. By coordinating expectations and providing a social network totransmit information, immigration made initiating a collective punishment .possible. At the same time, cultural factors made collective punishment afocal point. The Maghribis were mustarbin, that is, non-Muslims, whoadopted the values of the Muslim society. Among these values was the viewthat they were members of the same umma This term, although translatedas nation , is derived from the word umm meaning mother , reflecting thebasic value of mutual responsibility among the members of that society seefor example, Cahen 1990). Further, umma s members shared the fundaIuental duty notonly to practice good, bu t also to ensure that others did notpractice sin Lewis 1991). In addition, the Maghribis were.part of the Jewish.community, within which the idea that all Israel is responsible for everymember is prominent. Hence, immigration initiated by political factors inconjunction with social and cultural factors led to the emergence of the.Maghribi traders coalition.)9 For detailed elaboration on this argument, see Greif I994a, 1996, 1997a,b), Greif t l

1994)


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7 European Review conomic History

Similarly, the emergence of the patron system in Genoa reflects its generahistory. Towards the end of the twelfth century, the number of Genoeseactive in trade rose d r m ~ t i l l y .. Instead of the few dozen traders who hadpreviously been active each trade centre abroad, hundreds of Genoesebegan trading. At the same time, Genoa e x p ~ r i e n e demographic expansion,and its population was growing rapidly through immigration despite a highmortality rate. It seems that Genoa s population increased from 30,000 to100 000 during the thirteenth century (Bairoch et le 1988). This demographicand social setting did no t support the stable social networks required for thedevelopment of a coalition based on multilateral punishment. Genoa s cultural environment did no t support collective punishment either. Christianityduring that period placed the individual rather than his social group at thecentre of its theology. It advanced the creation of a new society based no t onthe family but on the individual, whose salvation, like his original loss of innocence, waspersonal and private (Hughes 1974, p. 61). Indeed, the. contracthrough which the Genoese established their city shortly before 1099 was onebetween individuals, no t between families or other so cial groups.4

N ot e t ha t th e argument here is n ot t ha t the Maghribis an d the Genoesefaced situations that were .identical in each an d every detail apart from theabove factors. The argument is only that th e institutions each achievedwould have been technologically possible in the other, an d the above factordirected th e process of equilibrium selection. In particular, given theemphasis on institutions provided by the state in economic history, it iimportant to stress that the institutions discussed above do not merelreflect the ability or inability of the state to structure exchange relationshipsTh e aspects of these institutions provided by th e state co-evolved with thosaspects t ha t d id not;- neither can be considered exogenous to the other.

Th e merchant guilds, for example, nicely illustrate th e complexity of threlationships between institutions provided by t he statean d those that arnot. Merchant guilds enabled people to believe in the effectiveness of constraints o n t he actions of rulers; at times, however, the success of their operation depended on intra-guild enforcement backed by the stateFurthermore, in the case of the German Ransa the need for inter-citcoordination led to the emergence of a new political unit. We cannot consider the Ransa as exogenous to the process through which institutions thagoverned the relationships between rulers an d merchants emergedFurthermore, cities .affiliated with the Ransa were no t motivated to retaitheir affiliation with it and follow its instructions because the state ha dmonopoly over coercive power. They were motivated by th e resultingecon

4 Clans, however, dominated Genoa s politics. This does not conflict with the argumentmade above. Th e bilateral agency relationships described .above often prevailed amongindividual agents an d those who invested on behalf of a clan: see Greif(I998c).


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utllie stream of rent. (See Greif et l 1994 for further discussion of thei, h.logenous formation of the Hansa.)Sin1ilarly, one cannot attribute the ,distinct institutions that governeda t ~ c n c y relationships among the Maghribis and the Genoese to a differentJH,litical environment. First and foremost, the Jews in the Muslimworldn \vell-developed legal system that was recognised by the Muslim authoritiesn its decisions were enforced, when needed, by the Muslim police.I;urthermore, Jews in the Muslim world were allowed to use, and at timest titl use, the Muslim legal system. Hence, it is misleading to consider the;\i\aghribis coalition as reflecting a lack of legal options. On the other hand,thl Genoese legal system did no t predate their commercial expansion. Itclllerged in response to a need to establish agency relationships, among()ther reasons - a need that would not have existed if the institutions governing Genoese agency relationships had been similar to .those of the.;\ \aghribis and based on collective punishment.

~ u r t h e r m o r e a coalition can prevail even if a legal system exists; theexistence of a legal system does not explain why agency relationships werenot governed by a coalition. Each of the institutions that prevailed amongt c Maghribis and the Genoese reflect distinct equilibria and not a differentlegal environment. Further support for this claim is gained from the observation that theVenetians developed yet another institution to govern agencyrelationships (De Lara 2000 Their institution relied heavily on contract.enforcement provided.by the state which also established a tight control ver trade in Venice and abroad. Venice s exclusive trading rights in various.l()calities abroad and restrictions on entry provided Venetian merchants\vith the stream of rent required to induce them to retain their affiliation\vith the city. Furthermore the city s administrative control overtrade provided it with the information required to evaluate agents conduct and topunish cheaters. Finally, the gains to the Venetians from this system provided it with the political support it needed to perpetuate. Hence, thecommon feature of the Genoese and Venetian institutions is the absence ofcollective punishment.The processes through which these institutions emerged and the details

f their operation.revealed by their explicit modelling suggest that each haddistinct implications. We have already seen that each institution had different social implications, implied different access to agency services (andhence dynamics of wealth. distribution), provided distinct motivation forinter-generational relationships and the establishment of family firms, andencouraged the use of distinct contracts. Furthermore, it seems that neitherinstitution could have supported the set of optimal exchange .relations..Among the Maghribis, the extent of agency relations l imited by thecoalition s size whichhad been determined by an immigration process.Indeed, the historical evidence indicates that the multilateral reputationmechanism led the Maghribis to forgo efficient relations with non-


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Maghribis in favour of more profitable bu t less efficient gen cy relationamong themselves. It should be noted that th e size l ~ m t t o n was a reflection of expectations, and thus this deficiency could have been remedied ban appropriate coordinating organisation, but it di d no t emerge.Yet th e coalition enabled a Maghribi to hire an a ge nt even w he n th erelations between them were no t expected to be repeated. This was no t th ecase under t he p at ro n system which cou ld support only repeated agencrelations. Furthermore, t he p at ro n system r eq ui re d a w eal th differentiabetween merchants an d agents that res tricted agency relation s. Ag ainalthough-this deficiency could havebeen remedied by an appropriate organisationsuch as th e family firm, it d id no t emerg e u ntil a cen tu ry later.Although th e above discussion suggests t ha t t he institutions which supported exch an ge d ur in g t he Co mmercial Revol uti on were no t optimabecause they di d no t solely_reflect th e needs of th e trade,. were they tendinto converge- to an o ptimal one? Were these ins titu tion s ind ucin g growthenhancing organisational -or technological innovations? Th e historical an dtheoretical analysis indicates -that this was no t th e case. Rather, these institutions were path-dependent in th e sense that th eir cap acity to chang e waconstrained by their own history.

The emergence of merchant guilds i n t he L at in world -entailed th e consolidation of political an d legal entities that shaped later institutional development. For example, th e emerging G er ma n H an sa was a new politicaorganisational entity aimed at preserving th e property rights of Germamerchants. Although its establisl)ment enabled northern European trade toflourish, once organised th e Hansa s concern was no t efficiency but profitability. In its constant effort to preserve trade rights an d supremacy, thHansa c rushed the advance of other traders groups without consideratioof their comparative efficiencies Dollinger 1970, Lloyd 1991).

The channel through which past institutions influenced trajectories iinstitutions that g ov erned ag en cy relatio ns are much more complex. Intrading societies, such as those of th e Maghribis an d th e Genoese, differeninstitutions that governed agency -relations consisted of distinct relation_between indiv idual s an d society which, i n t ur n, provided diverse incentive

r g r ~ i n g th e introduction of various organisations that supported collectivactions an d facilitated exchange. For a formal p resentatio n of this arg ument an d th e benefit from using an explicit game theoretic model, see Gre1994a.)

Among th e Maghribis agency relations were governed by a n i ns ti tu ti othat was based on economic self-enforcing-collective punishment an d wasupported by an ingroup social communication network. In s uch a collectivist society th e enforcement required t o s up po rt collective actions anfacilitate exchange could be achieved without formal - legal or politicalorganisations-specialising in communication an d enforcement. Among thGenoese, agency relations were governed by an institution based on bila


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he fundamental problemof exchange

l'ral punishment which reduced the benefit of communication. This .'individualistic' society ha d a relatively low level of informal economic enforcetl1ent over its members Hence to support collective actions an d to facilitatel'xchange there was a need to develop formal-legal an d political- enforcetl1ent organisations. In other words, the expectations associated ,with thenstitutions that governed agency relationships reflected an d became part'ofthe 'view of the world' or th e cultural beliefs of members of these societies.I'hese beliefs, in turn w ~ r extrapolated to situations that had not beenencountered before, thereby infllJencing the trajectory of institutionall'hange. They influenced .the ,outcome following exogenous change in situ;ltions a'nd provided incentives for particular trajectories of organisationalt'hange. Hence, they directed th e evolution of institutio'nal ttajectorybyInfluencing institutional change, organisational innovations and s o i ~ l'-;lructures.Indeed, the Genoese developed formal organisations to support collectiveactions an d exchange while the MaghriQis abandoned available ones.)uring the twelfth century th e Genoese ceased entering contracts with ahandshake an d developed an extensive, legal system for registration and'l'nforcement of contracts.. Furthermore, the customary contract law thatg()verned the ,relations among Genoese traders was codified as permanentl'ourts were established (Vitale 1955, Greif 1994a). In contrast, despite thel'xistence of a well-developed Jewish communal court system, the Maghribis .entered contracts informally, utilised 'an informal code, of conduct to governl'xchange, and attempted to resolve disputes informally (Goitein 1967; Greif.1< 89, 1993).This distinct organisational development is also well reflected in thedevelopment of merchant guilds in these two societies., Among thelV1aghribis compliance with embargo decisions was assured through inforInal means. After 'the Muslim ruler of Sicily abused th e rights of someIV1aghribi traders, the Maghribis responded by imposing, 'circa 1050, anel11bargoon Sicily. This embargo was organised informally, although theiVlaghribis could have, u se d t he Jewish court system or a Jewish communalf rmal organisation.4I In contrast, among the Genoese th e city of Genoaitself functioned as a formal enforcement organisation to ensure compliance\vith collective actions. After 'the city authorities declared that a certain area\vas a devetum that is, prohibi ted for t rade, any merchant found in thatlocation was subject to legal prosecution (Lopez 1943, Greif 1994a).

Th e distinctincentives provided by the collectivist cultural beliefs associated with the coalition an d th e individualistic cultural beliefs associated withthe patron system also manifested themselves in th'e emergence of ,other,(lrganisations. We have already seen the relationships between th e individ- I David Kaufmann Collection, Hungarian Academy of Science, Budapest, document #

2 2 a, ll. 29-31, b ll. 3-5, Gil (1983a), pp. 97-106; Greif (1994a).


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8 European Review onomi History

ualistic cultural beliefs of the Genoese an d th e motivation to establishfirin through which t he wealth of several merchants was aggregatedIndividualist cultural beliefs - n o t collectivist - also provided the incentivto use a bill of lading even though the first historical evidence for its use inEurope was from late medieval Genoa. n sharp contrast the Maghribisalthough familiar with the bill of lading, did no t utilise it. Hence, distincinstitutions led to an d reinforced distinct cultural features, which, in tumdirected these two groups along sepatate paths of organisational development. The importance of distinctive cultural beliefs to the evolution ofsociety s organisation is further exemplified below through the examinatioof their implications for other formal-organisations and social structures.Although th e above examples do no t lend themselves to quantifying theconomic implications of distinct institutions governing exchange relationships, they, do reveal the different implications of institutions. Consider thanalysis of agency relationships _among the Maghribis an d the Genoeseeach institution that governed agency relations ha d different efficiencimplications. Th e collectivist system is more efficient in supporting intraeconomy agency relations and requires less costly formal organisation such as law courts) but it restricts efficient inter-economy agency relationsTh e individualist system does not restrict inter-economy agency relationbu t is less efficient in supporting intra-economy relations an d requires costlformal organisations. Furthermore, each system entails different patterns owealth distribution, each of which is likely to have different efficiency implications. This implies that the relative efficiency of individualist an d collectivist systems depends on the magnitude of th e relevant parametersAlthough in the long ru n the Italians drove th e Muslim traders out of thMediterranean, th e historical records do no t provide-any explicit test of threlative efficiency of th e two systems., It is intriguing to note, however, that the Maghribis societal organisatioresembles that of contemporary developing countries whereas the Genoessocietal organisation resembles the developed West, suggesting that thindividualistic system may have been more,efficient in th e long run. Thanalysis thus enables conjecturing about the possible enduring benefits othe individualistic system. To -the extent that the division of labour isnecessary c on di ti on for long-run s us tai ned e conom ic growth, -formaenforcement institutions that support anonymous exchange facilitate economic development. Individualist cultural ,beliefs foster the -development osuch institutions an d hence permit a society to capture these -efficiencgains. Further an individualist society entails less social pressure to conform to social norms of behaviour an d thus fosters initiative and innovationIndeed, Genoa was well-known among the Italian city-states for its individualism an d was a leader in commercial initiative an d innovation.


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6. ConclusionsI ttl fundamental problem of exchange is inherent in any transaction and

lee the ways it was mitigated in past economies was central to their opertHtot l. It is reasonable to conjecture, as the studies summarised above indi-\ ute, that the legal and .private-order institutions that mitigated this problem .various historical episodes differed substantially even with respect to the

~ n t l l l . transaction. They differed substantially because even institutions that. { f1ectcd economic needs were an integral part of broader social, political,und cultural processes. Hence, they were likely to have had different econuntie implications and exhibit different long-run dynamics. Examining theUHf \.Ire and evolution of institutions that mitigated the FPOE in various

~ H H i c t i e s therefore, is likely to enhance our understanding of the determinants of societies distinct economic performance over time. lnly recently have scholars begun to study institutions that mitigated thefundamental problem of exchange in various historical episodes. Theftllcrgcnce of this research agenda reflects I the availability of new analyticntJl1cworks and. renewe d .awareness of the importance of institutions

rtling exchange. Scholars working on .this issue .have already examined I.verse institutions such as those that enablethe contractual estflblishmentof a political unit Greif 1994b, 1998c); enhance the ability of rulers to

llnt11it North and Wei:ngast 1989, Conklin 1998); govern the sale of legalnnd financial services and information Calomiris 1990, Rosenthal 1992 ,

~ t i n n a n e 1994, Hoffman et l 1998); and enable long-distance trade andtnvcstment in the absence of a legal system as we know it today Lamoreauxl{ jS6; Greif 1989, 1993, 1994a, forthcoming; Clay. 1997, De Lara

00 .4 I hese studies have c on tr ib ut ed t o our understanding of the o r i g i n s ~

fLtt.ures, and implications of institutions that mitigated the fundamentalpitlhlcm of exchange in various historical economies. By revealing the parth ltlarities of past institutions, each study also demonstrates,once again,ll< need t o s tu dy past economies in their historical context. Past societiesal cd economic problems similar to those of contemporary ones,but have\ t II 1fronted them in different ways. More importantly, each of these studiesihlvances us another step toward painting the larger picture of the historicalf l llution of institutions that governed exchange in various societies. Oncet i l t cumulative effect of s uc h studie s enables us t o see the broader picture this historical evolution in different societies we will be much closer tounderstanding the process through which some societies grew rich whileolhers did not. There is much that we c an gain from better understandingt).t the institutional foundations of exchange in past and present econo mies.

t StHnc other studies include Gustafsson 1987), Alston. and Ferrie 1993), Klein 1997),Banner 1998), Kroszner 1999), and Yung 2000 .


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AcknowledgementsThis article was originally delivered as a Keynote speech the European HistoricaEconomics Society,Lisbon, 29 October, 1999. I am grateful to the participants ithe conference, the editors, and an anonymous referee for valuable comments. .

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