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q ИНСТИТУЦИОНАЛЬНАЯ ЭКОНОМИЧЕСКАЯ ИСТОРИЯ
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www.hjournal.ru DOI: 10.17835/2076-6297.2016.8.3.006-034
ПОДХОД К ИНСТИТУТАМ С ТОЧКИ ЗРЕНИЯ СОЦИАЛЬНОЙ СИСТЕМЫ: ПРИМЕРЫ ИЗ ЗАПАДНОЙ ЭКОНОМИЧЕСКОЙ ИСТОРИИ
КОХЕН СОЛОМОН,
Школа экономики,
Университет Эразма Роттердамского, Роттердам, Нидерланды,
e-mail: cohen@ese.eur.nl
Хотя широкое определение социальных институтов как принятых правил поведения при взаимодействии агентов является общепризнанным, но мнения относительно того, как институты возникают и развиваются, лишь частично совпадают друг с другом. С различных точек зрения институты являются результатом эволюции, договора, конвенции, теории игр, политической власти со или юридической необходимости. Будучи созданы, институты могут жить своей о собственной жизнью и приобретать влияние на всю экономику или общество в
аспектах, находящихся за пределами их собственных истоков. Частично совпадающие взгляды на сущность институтов создают впечатление следования фрагментарным подходам при рассмотрении данных вопросов. Рассмотрение вопросов формирования и развития институтов в рамках теории и анализа социальной системы может заметно упростить картину и улучшить понимание. В этом состоит цель данной статьи. В статье показан и применен подход с точки зрения социальной системы для понимания формирования и развития институтов.
Статья состоит из двух частей. В первой разрабатывается аналитическая
ф структура, которая рассматривает экономику как социальную систему с
интерактивными подсистемами, которые инициируют и поддерживают свои собственные подсистемные институты. Некоторые подсистемы расширяются £ быстрее, чем другие, приобретая больше влияния. Взаимодействие агентов между < подсистемами облегчает доминирование более влиятельной подсистемы и ^ распространение институтов, связанных с подсистемой, по всей социальной системе. Вторая часть статьи иллюстрирует обоснованность подхода с точки ^ зрения социальной системы посредством обзора временной шкалы, которая о подчеркивает изменения и эволюцию доминирования основных подсистем и ^ прикрепленных к ним институтов в экономической истории западного мира и, в частности, взаимодействие между подсистемой фирм и подсистемой ^ государства.
0- Ключевые слова: институты; фирмы; государство; социальная система; ш интерактивное и регулирующее влияние; западная экономическая история; о промышленная революция; политические революции.
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THE SOCIAL SYSTEM APPROACH TO INSTITUTIONS: EXAMPLES FROM WESTERN ECONOMIC HISTORY
^ SOLOMON I. COHEN,
^ Erasmus School of Economics, Rotterdam, Netherlands,
^ e-mail: cohen@ese.eur.nl
О © Кохен С., 2016
While there is a general acceptance of a broad definition of social institutions as accepted rules of conduct in agent interactions, there are overlapping views on how institutions come into being and develop. Different views see institutions as the result of evolution, contract, convention, game theory, political power, or legal necessity. Once created, institutions can live their own life and gain influence on the whole economy/society in respects beyond their intrinsic origins. The overlapping views give the impression of pursued piecemeal approaches in addressing the issues. Treating issues of institutional formation and development in the framework of social system theory and analysis can be shown to simplify the picture appreciably and bring more insight. This paper intends to do that. It will display and apply the social system perspective to understanding institutional formation and development.
The paper falls in two sections. First, it develops an analytical framework that views the economy as a social system with interactive subsystems that initiate and maintain their own subsystem institutions. Some subsystems expand faster than others, gaining more influence. Interaction of agents across subsystems facilitates the dominance of the more influential subsystem and the spread of the subsystem's allied institutions to the whole social system. Second, the paper illustrates the validity of the social system perspective via reviewing a timeline that highlights the changing and evolving dominance of the major subsystems and their attached institutions in the economic history of the western ^ world, and in particular, the interactions between the firm subsystem and the state ° subsystem. ^
Keywords: institutions; firms; state; social system; interactive and regulative influence; o Western economic history; industrial revolution; political revolutions.
JEL: B12, N13, N20, N41, L50, F60, P16, P51.
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1. Introduction
Social institutions are broadly defined as durable sets of established and embedded social rules that structure and regulate social interactions. Language, money, laws, religion, the family, the firm, the state, etc. are all institutions. Social institutions, or simply institutions, relate to accepted rules of conduct in the sociological, economic, political, legal, religious, academic spheres, etc.
While there is a general acceptance of this broad definition of social institutions, there are overlapping views on the origins and functioning of social institutions. For example, there is the evolutionary view, Hayek (Hayek, 1960), which sees norms to emerge spontaneously in a bottom-up manner as individuals interact, and to evolve subsequently allowing the more fitting norms to become the regular norms. The contract view, Williamson (Williamson, 1985), sees social institutions as efficient solution to ¡5 problems of asymmetric and incomplete information. The convention view, Lewis ( Lewis, i 1969), sees the individual agent in optional situations, standing to gain from coordinated § behavior in the form of conventions bolstered by common experience and focal points. £ The game theory view, Schotter (Schotter, 1981), considers agents to be goal oriented ^ and to act strategically to create institutions that serve such goals. The political power w view, Knight (Knight, 1992), sees social institutions as the by-products of distributional q struggles between powerful and weak agents. Last and not least, a major portion of legalized institutions are backed by the legal necessity view, Sened (Sened, 1997). This perceives the state's enacting of statuary rules and state sanctions as essential conditions for establishing a conscious top-down institutionalization process.
The literature on the functioning of institutions adds more complexity. Once created, and are functioning, institutions succeed when they constrain agent behavior within intended boundaries, but institutions can live their own life beyond these boundaries. Two important issues have been raised in this respect, Hodgson (Hodgson, o 2002). The first is the possibility of the enacted institutions having a re-constitutive ^ effect on the preferences of the individual agents. The second is that institutions ^ strengthen the formation of habits that further tend to be inherited and outlive the q intrinsic needs of the institution concerned.
The wide range of views on the issue of the origin and functioning of institutions gives the sense that, in addressing the issue, piecemeal approaches were pursued. In the above views little or no attention is given to the totality of the social system or to its differentiated subsystems wherein the institutions actually originate and function. Treating issues of institutional formation and development in the framework of social system theory and analysis can be shown to simplify the picture appreciably and bring more insight. This paper intends to do that. It will display and apply the social system perspective to understanding institutional formation and development.
What is social system theory and analysis (SSTA)? It is an offshoot of general systems theory and analysis (GSTA), which is a cross-disciplinary collection of scientific thought that developed during the twentieth century; offering a great potential for systemic description and integration of separated theories into a single framework, with potentials of providing a common language for diverse disciplines, and of reducing disciplinary theories to a trans-disciplinary framework that can be comprehensibly mastered by more researchers.
In the context of social system theory and analysis (SSTA), the main proponents of this research program were Parsons (Parsons, 1956) and Luhmann (Luhmann, 1995). Their trans-disciplinary framework saw the economic system as one functional co subsystem, next to other functional subsystems pertaining to sociology (families and o social groups), politics, law, education, science, theocracy, etc. These subsystems act and ^ interact in forming together the whole societal system. Agents inhabit each subsystem, jg and engage in pursuing a specific goal that is characteristic to each subsystem. In its - pursuit of fulfilling its specific goal, each subsystem functions by itself, sets ups its g organization, and adapts itself to other subsystems and the changing environment. ° The social system research program of Parsons and Luhmann failed to mobilize
® economists and other social scientists to rethink and integrate their fields of ^ specialization along the proposed lines. The main reason is that the mono-disciplinary approaches are strongly established in each field, and have produced intelligible outcomes that serve their purpose. Besides, moving towards a trans-disciplinary approach requires the presence of conceptual frameworks with common principles that describe how the various subsystems operate and interact with each other to produce the whole system. The development of such conceptual frameworks requires, in turn, substantive organized cooperation and pooling of joint resources. Since these conditions are not present it is more rewarding to keep to one's own discipline. Additionally, while Parsons and Luhmann are to be accredited for launching the idea of SSTA, yet they did not go in any length in formulating general principles, entities and variables that relate ^ to evolution of the subsystems and their interactions with each other. This has resulted o in an open-ended proposed agenda that did not encourage research in unified social ^ systems.
§ In Cohen (2009), and with further elaborations in Cohen (Cohen, 2014; 2015), an
attempt was made to comprehend and analyze the functioning of the economy along the lines of social system theory and analysis. We distinguished between three main oj behavioural settings centered around respectively the household, the state, and the firm, o and their corresponding functional subsystems. The agents in these three functional ¡^ subsystems are driven by three distinct motivations; respectively: the social, the political ^ and the economic motive. This paper pursues this line of analysis. The conceptual g framework we develop emphasizes (a) the location and interaction of agents in distinct F behavioural settings. It then moves to (b) their aggregation in correspondingly distinct H functional subsystems, each with its own corresponding institutional setup, challenges, co opportunities and growth performance. Some subsystems grow more than others and gain dominance. (c) The analysis highlights the interactions of agents within and across o the subsystems, and the subjection of these interactions to systemic influences, that < ultimately lead to a convergence of agent behaviour and institutional governance o^ towards the particular behavioural traits and institutions that associate with those of
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the most dominant subsystem. (d) One can speak of a system prototype that applies for a group of countries when high degrees of melting and integration in their dominating institutions are observed. (e) System evolution is highly influenced by the external environment and historical events, which are difficult to predict and control.
In the way of examples, the current dominance of the firm subsystem and related institutions in the western countries can be shown to be the accumulated result of many past events: wars, discoveries, colonies, trade, political enlightenments and industrial revolutions. The strengthening of the firm subsystem took centuries and has been accompanied not only by a weakened intensity of rival subsystems (those of traditional households, theocrats, manors, communes, royals, and not least the state subsystem), but also by a reorientation of the intrinsic motivations in these rival subsystems towards the motivational behavior characteristic of the firm subsystem.
The paper will contain two large sections. Section 2 will review briefly the social system conceptual framework with focus behavioural setting, functional subsystems and their enacted institutions, the roles of systemic influences, formation of system prototypes, and system evolution. Section 3 will apply the conceptual framework to a historical sketch of the western world. We shall review the timeline of the changing dominance of rival subsystems and their attached institutions. In particular, the focus is on the dynamics of the state and firm subsystems and their institutional developments. ^ Section 4 concludes and discusses some implications. °
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2. Conceptual framework of the social system approach o
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2.1. Behavioural settings
Conventionally, a behavioral setting is defined as a physical site populated by interacting persons who have become members of the setting by accident and/or choice. * Behavioral settings relevant for economic analysis are those that generate for their ^ participants added value from the economic transformation of some production and/or 1 exchange activity. Agents inhabiting a behavioral setting engage thus, in a value added g transformation of goods and services. Actions of agents are subjected to physical-technological boundaries and guided by institutional rules and information schemes. 5 Setting types of significance and interest for economic analysis are those of the
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household, the firm, and the state settings, mainly governmental1. These three types of ^
settings will be denoted by h, f, and s. Agent behavior and transformation processes in <
the household, firm, and state settings, and the institutions regulating them, are driven g by intrinsically distinct goal functions. For example, affinity sharing is the underlying
intrinsic motive in household settings. Agents in household settings are united by f?
kinship, ethnic, locality or religious ties and adopt initially institutions of reciprocal o
exchanges and the collective sharing of benefits and costs. In contrast, profit ^
maximization is the intrinsic motive in firm and market settings; while acquisition of a ro polity rent and political advantages attached to the political intermediation are the
intrinsic motives in state settings; in short, rent politicization. S-
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2.2. Functional subsystems o
A specific subsystem consists of a vast number of behavioral settings of the same ¡^
specific type. Proceeding from the level of settings to the level of subsystems involves ^
objectifying the settings, depersonalizing and turning them into entities, and g
supplementing these entities by additional institutions for safeguarding the f
sustainability and expansion of the subsystem2. Each subsystem has its own ^ institutional rules and information schemes for guiding actions of the agents present in that subsystem. We shall denote the subsystems corresponding with household, firm,
1 By state settings we mean the legislative and executive branches, i.e. government. The state subsystem does not include the judiciary, which is a separate functional subsystem. Though it becomes a part if the government is fully controlling the judiciary < in the context of the country concerned. ^
2 Our modelling of the formation of subsystems draws on thoughts on interaction within social groups in (Simon, 1952), and on z> institutional growth in (Zysman, 1994). O
and state settings, by capital letters H, F and S, respectively. Of course, there are other subsystems that are indirectly engaged in economic transformations, or not engaged at all, but may have significant bearings on the economy. The role of other subsystems will be reviewed where relevant.
The goal functions are distinct and intrinsic in the three types of settings/ subsystems. While the intrinsic goal in the household subsystem is described as affinity sharing and coordination mechanisms have a sociologic character, the goal in the firm subsystem is profit maximization and coordination mechanisms are economic in character. The goal in the state subsystem is rent politicization, and coordination mechanisms are political in character. The distinct behavioral motives of the three subsystems can be expressed formally in an equation forms3. Expanding on the above, in the household-communal subsystem, the motto of the homo sociologicus is most applicable: from whom according to his ability and to whom according to his needs, resulting in social sharing and committed reciprocity. The firm subsystem functions along the homo economicus where choices in production and exchanges are made to assure that material benefits less costs are maximized. From who according to his abilities and effort and to whom in accordance with his relative abilities and efforts is the rule of the game. In contrast, the state subsystem is represented by the homo co politicus, this is a state authority who brokers a settlement among insecure and/or
0 differing parties in ways that guarantee security and resolve conflict peacefully, with ^ simultaneously strengthening institutions that bolster power and protective rent for the
01 state authority. The rule of the game in the state subsystem is close to what can be described as from whom according to his maximum negotiable ability and to whom according to his minimum negotiable needs. The difference between the two volumes is the polity rent that the state acquires.
While each subsystem is in some sense a sum of its own constituent type of settings, there is more to that than being a simple sum. Each subsystem is a functional whole by itself, and has to find its manners of survival and growth respectively, in the face of external challenges that can encourage free-riders to cheat on their companions and weaken the subsystem, and in the face of opportunities that can encourage pioneers to expand and strengthen the subsystem. Events in the external environment impact significantly the expansion and exhaustion of the comparative advantage of a subsystem in activities that the subsystem is most suited to transform. Under the circumstances, each subsystem engages in establishing and applying governing institutions backed by sanctions and rewards that are tailored to fulfil two tasks: eliminating free riding among members and securing the sustainability of the subsystem, thus leading to a deepening of the goal function of the subsystem; and improving the functioning of the subsystem and bolstering its growth prospects, thus leading to the spread of the goal function of the subsystem.
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^ 3 In the household setting, h, agents lump together their benefits and costs in an effort to make total benefits exceed total costs.
" In eq. 1, Vh stands for the value added in the household setting, while rewards R and efforts E of agents i and i' are lumped
Oj together and somehow shared among all i.
§ Vh = Ri + Ri■ - Ei- Ei■ > 0. (1)
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In the firm setting, f each agent aims at the highest economic returns to one self, which implies aiming at realizing the highest <C return to the firm as a whole, above an opportunity cost margin p.
Vf = T(Ri - Ei) / TEi > p (2)
To model the state setting, introduce the subscript ps to denote the pre-state situation (before engagement of the state), and subscript s to denote the situation after engagement of the state., and k to represent state agents eq.3 shows a lower value added in the pre-state situation compared to the situation with state engagement.
VpS = IRpSi- lEpsi < 0, Vs = TRi- IEi - IEik > 0 (3)
< Institutional rules in state settings give the governing agent, k, the exclusive authority to acquire a polity rent from all agents for
the polity services rendered, denoted by Eik. Furthermore, institutional rules in state settings tend to be molded in manners that require prolonged dependency of agents, i , on agents with state authority, k, and collection of polity rent in the future if 2 transformation is to be realized and maintained in future transactions.
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How do processes of establishing institutions occur? Within a subsystem there are 'leader' agents with significant interest sufficient enough to feel the need for collective action and for enacting common behavioural norms for members of the subsystem to abide with. Once the leaders bring out the institutions, 'follower' agents are pursued or compelled to abide with these institutions.
2.3. Systemic influences
Subsystems influence each other, with usually one overgrowing and the others growing but lagging behind. It is necessary to have a clear and precise formulation of what we mean by influence of one subsystem on other subsystems. Once done, the way is open for proposing operational measures of systemic dominance. Focus is on two dimensions of influence; interactive influence and regulative influence.
Interactive influence relates to the intensity of participation and activity of the agents in one subsystem relative to other subsystems. To start with, in any country there are active agents in households, firms and state subsystems in large numbers. The same agents can be members of more than one subsystem simultaneously. Agents communicate with other agents within their own subsystem and with other subsystems. The exchange of information and communication on performances of subsystems activates the realignment of agents towards the better performing subsystem. This leads over lengthy periods of time to relatively greater concentrations of agents in one subsystem then another, say subsystem B gains on subsystems B', opening the way for the spread and dominance of the institutions of B over B', and of the behavioral traits that coincide with those of subsystem B, over those of B'. Once a threshold is reached with regard to accepting a specific behavioral type, say that of B, this can be expected to gain momentum in view of network externalities, and spread further to all other B's.
There is a vast literature on the adoption and spread of a particular behavioral • type among more agents. Some six mechanisms of agent interactions, that may include overlapping, can be singled out as determining the formation of the common behavioural 1 pattern, its spread and dominance. (1) Sharing of the same external environment and g past history fosters convergence towards a common behavioral type. (2) Agents observe the transformation outcomes in alternative settings, and move to the advantaged setting 5 or copy its behavior thus resulting in the prospect that the typical behavior of the advantaged subsystem becoming prevalent. (3) Intensive and extensive interactions and communications of agents participating in several subsystems are prone to extend the prevalence of the advantaged behavioral type that associates with the most growing and dominant subsystem. (4) Network externalities enforce convergence towards the advantaged behavioral type. (5) The deep-rooted social-psychological inclination of individuals toward consistency in their relationships and cognition ends up in adopting a positive attitude towards the preferential behavior of the dominant counterpart. (6) Other related mechanisms include imitation, convention, focal points, information 5 cascades, reciprocal behaviour, group learning, Markov chain inversions, melting pot, and power of dominant shares, among others4. S
Of course, next to all the interactive mechanisms, external events and qj environments play major roles in strengthening or weakening the relative dominance of o the competing subsystems, and thereby contribute significantly to speeding up or ^ obstructing the convergence tendencies towards one integral system that associates with ^ the dominant subsystem. g
Summing up, the better performing subsystem attracts more agents from the f less performing subsystems, gains in interactive influence, and takes the lead in ^ interactive dominance. Supported by the above interactive mechanisms, the lead is co strengthened; and the behavioral motive of the dominant subsystem is likely to become the norm for the whole system in the long run. Thus, one subsystem is very likely to o evolve into, and be identifiable with the whole system. <
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and Smirnov, 2004; Simon, 1993). O
4 See: (Banerjee, 1992; Bikhchandani, Hirshleifer and Welch, 1998; Frank, 1988; Goodin, 1993; Schelling, 1978; Brueckner
To drive the point at the cost of some exaggeration, it can be reasoned that in the US, for example, the high concentration of agent interactions in firms allows over time the goal of profit maximization that is intrinsic to the firm subsystem to overshadow the intrinsic goals typical of the household and state subsystems. Similarly, it can be reasoned that comparable assimilation processes, tended to oblige agents in household and firm settings in Soviet Russia to follow a politicized behavioral motive typical of the state subsystem. As a result, all three subsystems in US behave in ways typical of firm settings, while in Soviet Russia they manifested behavior typical of state settings5. The above implies that agent behavior, institutional conduct and outcome performance of the whole system will tend to be relatively homogeneous and reasonably predictable. A social system has its sociological, economic and polity aspects, or subsystems, that describe together the whole social system. It is logical to expect high degrees of consistency and correlation between the sociological, economic and polity aspects of a specific social system.
The interactive influence of subsystem B on other subsystems can be quantified using a Dominance Index (DI), denoted by DIb. The index has two arguments relative share of agents in B and relative share of transformations in B. See eq. 1.
DIb = (m Ab + m Cb) (1)
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0 In this equation, there are two share parameters that affect prevalence. Ab is the ^ share of agents in subsystem B, with respect to all agents in all settings. Cb is the share ^ of commodities demanded that are most suitably transformed in subsystem B, with
- respect to all demanded commodities. Personal commodities are most suitably s transformed in firm settings. Collective needs are most suitably transformed in state ° settings. Eq. 1 proposes that the greater the shares of those agents and commodities • associated with a particular setting the greater is the probability that the behavioral >"5? type underlying this setting prevails over other behavioral types. In this equation, m
1 and m are weights applying to these two shares, whereby m + m = 16.
g The dominance Index, DIb, is indicative of the interactive power of subsystem B
over all the other subsystems B'. Quantification of this index can be done at lower levels (for specific firms within an industry, for specific industries within the whole economy, for specific agencies within the state subsystem). It can be applied also at higher levels, i.e. for individual countries within a world region or the world economy as an indicator of the relative influence of individual countries, see (Cohen, 2015).
Moving to regulative influence, this arises in a situation in which a behavioral setting b happens to stand higher in relation to b' in the hierarchy of settings; allowing b to set behavioral rules typical of b that other settings b' should abide with. In this way, o the behavioral type of b overrides b', allowing the further spread of behavioral norms of s b at the cost of those of b'. The example is extendable to the level of subsystems. The ro origin of the regulative influence lies in the ability of the higher subsystem to impose ^ binding rules of conduct on the lower subsystems. One example: the imposition of the regulated workday by firms on households had significant regulatory effects of the firm subsystem on the household subsystem. The other example: in regulatory terms, the state subsystem stands above the firm subsystem; though this is legally correct, state regulations of industrial activity can hide an indirect regulatory influence of firms on the sate in case of capture. Apart from quoting examples, it is not feasible to give
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3 5 The examples can be elaborated further. For instance, in the US the polity can be described to have adapted itself to the economy. Next to constitutional checks and balances, and an independent judiciary system, that keep state discourse in control,
y) profit maximizing firms and utility maximizing agents have installed more institutions for controlling state conduct, and bent
2 the polity towards behaving along the same norm of maximizing economic returns, In contrast, in Russia the polity can be seen
ll as exogenous to the economy.
^ 6 The two shares are not independent of each other. For instance, Cf affects Af positively in the long run, while when relatively
< more agents go in f, thus increasing Af, the potential for demanding and producing the/type of commodities is enhance, and
^ thus Cf is influenced positively. In spite of the interdependence the two shares stand for different aspects that feature the
ZD identification of the economic system. It can be expected that the two shares correlate, which is an argument for giving them
^ equal weights in the simple aggregation equation.
meaningful quantifications of the degree of regulative influence as in the case of interactive influence. Quantification is obstructed by difficulties in standardizing diversified measures of state regulation across countries. Besides, the state regulations are robbed of their meaning in cases they are captured by firms.
While the dominant power of the firm subsystem in western countries has been the result of the past growth of interactive influence and is less the result of a regulative influence of the firm subsystem on other subsystems, it is generally believed that the accumulated power of state authorities consists mainly of regulatory influence. Economists have studied in depth the nature of the regulatory influence of the state subsystem on the firm subsystem, and vice versa; with surprising findings that are generally acknowledged7, stating that a very large part of the state regulations on producing firms is interpretable in terms of models of 'producer capture' and not of 'public interest'. Although the extents of the firm's manipulation of the state's regulations differ by sector and duration, the following hypothesis can be stated to be generally valid: In the country context, where the F subsystem is all dominant and the S subsystem is subordinate, such as in US and less so in EU, the regulative influence of the S subsystem is for the greater part fake and capture. In contrast, in the past Soviet Union, where the state was all dominant, the regulative influence of the state on firms was absolute and real. ^
There are subtle differences between the interactive mechanisms and the ° regulative mechanisms. The interactive influence represents the results of horizontal ^ integration. Regulative influence is a vertical relationship. It can be speculated also that o the contribution of horizontal channels towards unified behavioural formation across
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subsystems is likely to be more influential and more permanent than that of vertical channels. Being generated via experiencing, learning and adoption horizontal interactions are likely to have more endurable effects. In the case of vertically ® accommodated behavioural attitudes, the regulative influence can terminate abruptly if the regulative mechanisms become too demanding due to technological loopholes, or the 1 rationale for the binding restrictions disappears, or the balance of power between b and g b' reverses. Furthermore, it is likely that there is a positive association between the two notions, in the sense that a subsystem powerful in interactive influence is also powerful 5 in regulative influence8.
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2.4. System prototype
Agent mobility and communications between subsystems in the direction of the better performing subsystem, together with network externalities, quest for balancing, etc., and sharing the same external environments tend to end up in one dominant
behavioral type typical of subsystem B over other B'. As such, the result is a o
homogeneous social system that can be approximately described in terms of the ^
dominant subsystem. ro
Given the three prominent subsystems and given large numbers of agents
inhibiting each of them, vast volumes of transactions and communications in each and 5.
between them, and the pulling forces as well as the pushing forces, it is conceived that £3
over long periods of time; any of the three subsystems can evolve into dominant whole o
systems, meaning that one can speak of three broad prototypes of economic systems that ¡^
are observable in different parts of the world. Of course, it is unlikely in the real world ^
that complete convergence occurs, in the sense of 100 per cent of all agents converging g
towards the same motivational behaviour of the dominant subsystem; hence, speaking of f
prototypes of economic systems rather than absolute systems. t
The first prototype, and the oldest, is the economic system that centres on w households and in which agent behaviour and institutional rules in the whole social
system have adapted to household behavioral traits. This can be called the household o
7 See: (Stigler, 1971; Joskow and Rose, 1989; Winston, 1993). Z
8 There is some evidence for OECD countries of a positive correlation between the degrees of public regulation and public 3 spending. See (Borcherding, Ferries and Garzoni, 2002). O
intensive system, HIS. In the real world, many rural regions within developing countries would qualify as HIS. At the country level there are limited examples that fully operate along the lines of HIS. The second prototype is the economic system where agent behavior and institutional rules in the whole social system adopt a firm-like behavioral type, i.e. maximization of economic returns. The firm intensive system, FIS, has many copies in the real world; the best example is US. The third prototype is the economic system where agent behavior and institutional rules have adapted to a state-like behavioral type that is characterized by rent acquisition and political advantages. In the real world Soviet Russia was the typical example of a country that operated along the state intensive system, SIS. Russia has changed since then but it remains closest to the SIS in relative terms.
2.5. System Evolution
It is helpful to postulate the development of the three subsystems as an outgrowth from some common origin, which is by definition, the customary household settings. Now that there are firm centred and state centred economic systems, then how did they proceed from the customary households? Which subsystem came first: F or S? And subsequently, which factors strengthen the sustainability and further development co of these two systems? And which factors weaken them? The answers to these questions o can be approached in theoretical or historical ways.
^ In terms of theory, Hicks (Hicks, 1969) is among the first economists who
theorized that tribal chief, feudal landlord, army and state settings have preceded firm - and market settings. Social anthropologists, like Firth (Firth, 1967), maintain that g economic organization and the transformation and exchange of products within and ° between neighboring primitive societies came first and preceded political organization. ® Broadly speaking, the following premises would allow for both scenarios. (1)
Agents inhabiting household settings, and interacting with each other in a communal environment, experience specific needs, or can be attended to uncovered needs, and they are ready to embrace these needs. Agents are also innovative and capable of finding solutions and creating new transformation settings that satisfy these needs. (2) The needs of an agent can be personal or collective9. Personal needs of one agent can be directly satisfied by the innovative and responsive transformation offered by another agent; opening ways for exchange and firm settings. Collective needs are indivisible and their satisfaction would require a joint effort of agents and a third party intervention to coordinate the task at a higher level; which opens ways for public goods, delegated authority, and state settings. (3) In communities where personal needs happen to have an overweight, the firm setting will emerge and prosper. In communities with an overweight of collective needs, the state setting will emerge and prosper. (4) Furthermore, the external environment is a basic determinant of behavioural settings and the behavioural type that characterizes the setting. Different external environments generate typical coordination structures that coincide and fit with typical behavioural 5. settings.
ft] In terms of history, analysis of past records of world events should be able to
o answer such questions as how was the configuration of the system in a very distant past, and how did it develop further? Events in the external world have differential effects on ^ competing subsystems. As the next section will demonstrate, the external environments g are continuously changing as world development moves on, causing intermittingly F weakening effects and strengthening effects for both the F and S subsystems. It is sufficient to mention here a few examples to make the point clear. The ages of geographical discovery and colonial conquest in the 14th-17th centuries strengthened both subsystems in Europe, though more so for S than F. The industrial revolution in the o 18th-19th centuries brought technological advances, which enhanced major < diversifications in demanded private goods, a huge jump in personal needs of the newly
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O 9 Satisfaction of these two types of needs corresponds with the distinction between private and public goods.
settling migrating populations and a significant push for the firm subsystem. This period saw also the subjection of state governance to constitutional law, which in terms of dominance, was equivalent to a downgrade of the state subsystem and an upgrade of the firm subsystem.
3. Historical developments
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3.1. A timeline with systemic relevance
There is a vast literature on the economic history of western countries. Our concern is with the evolving spread of the firm subsystem at the cost of other subsystems: how historical events/changes strengthened the firm subsystem vis-à-vis other major subsystems, and allowed the firm subsystem to eventually dominate the whole system.
The drive towards dominance of one subsystem on other subsystems is comparable to a long marathon race that goes through mountains and valleys. The chasing subsystems change positions as frontrunners, with some of the front running subsystems at one time losing strength or dropping out altogether centuries later. In Europe, the marathon began in a period of fragmentation and vacuum, around 900 or 1000 A.D. Once the race was started, the leading subsystem at the time (that of traditional household settings) experienced a continuous loss of agents and transformation to the benefit of rising subsystems. A spectacular gainer in the 11th- 14th centuries was the theocratic subsystem (church and related settings), but this dwindled in later centuries. The feudal-lordship-manorial subsystem (an overlapping combination of feudal, lordship, and manorial settings) was another spectacular gainer in the 10th-14th centuries, but was destined to disappear completely five centuries later. The subsystems of manor law, urban communes and the central monarch started also in the * same period, and it took them another five centuries of reformist and constitutional revolutions to evolve and fuse into the democratically elected state subsystem that is I characteristic of western countries today. Small in size but rising in terms of agents and g transformations were merchants and craftsmen. Although the trading, crafting, and cottage industry settings expanded with expanding markets for goods, labor and finance, 5 it was only six centuries later, with the industrial revolution, that these settings developed into firm settings; and it took the firm subsystem two more centuries to evolve to their present dominant position in western countries. In the subsequent subsections we fill the details of this introductory paragraph.
Historical analysis commonly pinpoint particular years or periods as a starting point for analysis, though conditions in any year or period are the result of conditions in earlier years and periods. This makes it difficult to select a starting point. However, if o one would replace the microscopic approach with a macroscopic perspective, and ^ interpret history in terms of phases, the task is simplified. Historical evidence on Europe ro would indicate and justify the 9th-10th century A.D. as a starting period for the marathon E^ race. At that time the subsystem of traditional households and kinship related settings (i.e. villages and tribal groups) was still dominating the whole socio-economic and ffi political system; in short, it was a household intensive system, HIS. H. J. Berman o (Berman, 1983) gives an elegant description of the dominance of the H subsystem in Europe, at and before that time10. ^
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10 From (Berman, 1983. P. 61): «The earliest known legal orders prevailing among the peoples of northern and western Europe
were mainly tribal in character. In the period from the sixth to the tenth century, ... on the one hand, the basic legal unit within q
the tribe was the household, a community of comradeship and trust based partly on kinship and partly on oaths of mutual _i
protection and service. Violation of the peace of the household by an outsider could lead to retaliation in the form of blood feud, ^
or else to inter-household or inter-clan negotiations designed to forestall or compose blood feud. On the other hand, there were CC
territorial units consisting typically of households kinds of (feudal) lordship-household bonds». q
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Fig. 1. Timeline of the firm intensive system in western countries 1000-2000+ Source: compiled by the author.
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The period of the 6th to 10th century experienced major upheavals. A series of territorial wars between the various tribal groups, peoples and territories in Europe was further exasperated by the external invasions from Islamic armies and failure to stop the defeat. The uncertainties and fragmentations of the time led to two important responses: one is the strengthening of religious settings (Christian church) and their regulatory influence on household behavior, and the other is the emergence of feudal settings (overlapping with lordships and manors) that embodied/subdued households. These two developments signaled the beginning of the end of the dominance of the household subsystem. We draw in fig. 1 a timeline for the evolvement of the economic system of the western world that starts accordingly from the 1000 A.D. to present day. The timeline depicts events and effects, categorized in various epochs, which are relevant for our subject matter. The timeline shows subsequent ages of world development, some were inspired by thoughts (shown above the timeline), while others were driven by events (shown below the timeline). These world developments created and strengthened the firm and state subsystems, F and S, and added other subsystems, at the cost of the H subsystem. As will be shown, the accumulated gains for F were greater than for S. The timeline depicts four long periods, with earlier periods longer than latter periods. The first period is the genesis of the contemporary socio-economic and political system, it covers 400 years (1000-1400), the second covers 300 years (14001700), the third covers 200 years 1700-1900, and the fourth is years 2000-2014.
3.2. The period of 1000 to 1400
As was just stated, uncertainty, fragmentation and defeat in the 6th to 10th century were at maximum levels, the dominant traditional household subsystem already started to crack down, and newly emerging subsystems started showing their mussels. The 11th to 14th centuries provided historically the right times for newly emerging settings to consolidate themselves into emerging subsystems and establish institutions that assure their sustainability. Foremost among the newly emerging subsystems was the theocratic subsystem. Christian churches more than multiplied in the 11th and 12th
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centuries11. The Christian Church was able to organize itself internally as a consolidated theocratic subsystem, subdue the power of the monarch in several respects, and dictate the course of the crusading wars; in what has been named the Papal Revolution. Another important subsystem that gained strength was the feudal-lordship-manorial subsystem. The joint occurrence of the crusading wars, economic growth and demographic expansion strengthened the rise of another subsystem, that of urban towns, merchants and craftsmen. Emboldened by the institutional successes of the papal and manorial subsystems, the urban communes and trade guilds started developing and organizing themselves as important subsystems, as well. Commune and guilds were closely linked. Sometimes the establishment of merchants guilds preceded a commune, and sometimes otherwise. We shall briefly review the rise and growth of these subsystems.
The theocratic subsystem. One can speak generally of Christian churches in their plural form, but in its singular form, the Christian Church encompasses and subjugates all churches, and develops unified codes of conduct for its subsidiaries and for participating household agents in what is known as the canon law. It was only in the 11th century with the commencement of the Papal Revolution that the Christian Church organized itself as a coherent and unified theocratic subsystem, and was able to exercise substantial influential powers on other subsystems. The Papal revolution consolidated ^ the hundreds of churches, bishops, services and millions of worshippers in a holistic ° subsystem with adhered institutions, established canon law, wrote down property rights ^ of monasteries in charters, instituted the papal curia, and delineated the independent o authority of the Church from that of the monarch. Dictatus papae, initiated by Pope Gregory VII circa 1050-1080, has been named as the Papal Manifesto by legal historians. It is based on the principles of papal primacy, and the conviction that the > Church was founded by God and entrusted with the task of embracing all mankind in a ® single society in which divine will is the only law; and that the pope, in his role as head of the Church, is the vice-regent of God on earth, so that disobedience to him implies 1 disobedience to God: or, in the extreme, a defection from Christianity. The manifesto g acknowledged the existence of the monarch as a dispensation of Providence, described the coexistence of church and monarch as a divine ordinance, and gave them the joint 5 right to share the investiture of bishops. The manifesto demanded also the centralization of ecclesiastical government in Rome (all important matters of dispute referred to Rome, and appeals were to be addressed to the pope) and this meant the curtailment of the powers of bishops. The Papal revolution impacted significantly the evolution of the European society. It revived compulsory celibacy among the clergy and gratis simony (payment to receive sacrament), promoted the significance of the written word in law and court proceedings, strengthened constitutional authority, made o authority negotiable between power holders, and strengthened belief in the rule of law ^ in guiding conduct and resolving conflicts. However, the narrow interpretation of the ro supremacy of the Papacy carried it with it weakening effects: it led to the estrangement of the Eastern Church, and would spark one century later the Protestant Reformation S. with significant weakening effects to the theocratic subsystem. ffl
The crusade wars were a major world development of the time. The aggressive o and reformist Papacy under Pope Gregory, went further than its assertion of independence from secular rulers to advocating holy wars to retake Palestine from the ^ Islamic rulers. The first crusade in 1095 was followed by six major crusades, all of them g sponsored jointly by the Church and various European monarchs and nobilities. Several f hundred thousand Christian land workers from all over Western Europe were mobilized E: under feudal command, and became crusaders by taking vows and by receiving plenary indulgences. The majority of crusaders were poor people trying to escape the hardships
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11 Buringh and Van Zanden (Buringh and Van Zanden, 2006) estimate the average percentage increase of monasteries in the 6th ^
to 10th century to be 49% per century, jumping to 91% and 64% in the 11th and 12th centuries, and there after falling to 17%, 6% CC
and 4% in the 13th, 14th and 15th centuries. O
of medieval life in an armed pilgrimage with a godly blessing and a promise that their sins will be forgiven. Taking part in a crusader war was seen as Christian redemption, and a form of penance that remits sins. It is comparable to radicalized calls for Islamic jihad.
Leaving the damage done by the crusades for what it was, of particular relevance for this paper is the impact of the crusades on the evolution of the socio-economic and political system in Europe, which was profound. The traditional household subsystem was overturned. Land cultivators left for the wars overseas, leaving control of their estates with regents, often wives or mothers. Recognizing the war risk to families and estates the Church organized special papal protection, which meant an accelerated influence of the theocratic subsystem on household settings, and a further decline of the traditional household subsystem12. The impact of the crusade wars on economic activities was even more significant. Recruiting and feeding hundreds thousands of fighting soldiers required a special effort to enlist soldiers and to produce an agricultural surplus. The supply side was there and was able to meet the increased demand. The result was a big push to economic growth, which raised demand and supply in subsequent rounds. The 11th to the 14th centuries experienced significant increases in agricultural acreage (due to forest clearance), increased agricultural productivity (through use of heavy plough, crop rotation, horse power and water mills), and efficient exploitations of land and peasants by a feudal regime (that gained strength as a supplier of food and soldiers to the crusades). The period had fortunate climatic conditions as well. These factors resulted in an economic boom in the sectors of trade, transport, crafting and metal objects making, and a rise of rural-urban towns. The surge in population, though temporary, was an additional stimulus.
In the previous section a measure of subsystem dominance was proposed. We postulated that the extent of interactive influence of subsystem B depends on the relative degrees of agent participation and of economic transformations that take place in subsystem B compared to other subsystems B'. Even though we do not have data on church attendance in the Middle Ages, this must have been very significant since church attendance was mandatory. Besides, the crusade wars increased theocratic participations in other manners as well. On economic transformations, it is interesting to note that historians estimate that the theocratic subsystem possessed in the 12th century between 1/3rd and 1/4th of the usable land in main countries in Europe; with large portions of this land cultivated and governed along feudal-lordship-manorial rules, with appointed bishops functioning as custodians13. Taking all these data into consideration, the theocratic subsystem is likely to have been the strongest subsystem in economic terms in the 12th century.
The feudal-lordship-manorial subsystem was likely the second in rank. The warlike environment, risks, uncertainty and fragmentation of the 9th and 10th centuries brought well off landlords and impoverished peasant together in a durable and influential network that spread further in the 11th and 12th centuries. The feudal subsystem was strengthened by the institution of manorial laws, which are conventions ft] guiding the functioning of rural communities, usually biased to the advantage of lords on o peasants. In the feudal subsystem in Europe, the monarch loaned land to vassals (i.e.
lords, often belonging to nobilities) in exchange for loyalty and protection. At a lower ^ order, the lords loaned land to their own vassals (i.e. peasants), and so forth. There were g thus different levels of 'vassalage'. Lords and peasants shared a reciprocal relationship F regarding legal, land and military obligations, cf. (Reynolds, 1994). The lord granted ^ lands to peasant households in exchange for military service and working the land, whilst the vassals were ensured work, homes and protection. The nobility's class and feudal lordship often overlapped: in many instances they combined, but there were also
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<; 12 Theocracy-driven adherence in the Middle Ages, which had the effect of undermining the household subsystem and family
institutions, are not unique. Comparable ideals prevailed in the communism-driven adherence in the 20th Century with similar results in China, Vietnam, and some of ex-Soviet Union republics. o 13 See: (Berman, 1983), chapters 2 and 3.
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landless nobles and non-noble feudal lords14. The feudal subsystem gained momentum with the crusade wars. It was a main supplier of soldiers and food. But the growth of the feudal subsystem and manors began cracking in later centuries as social mobility among peasants increased and the bondage with land decreased (due to peasants acquiring crafting skills, higher earnings, buying their freedom, and moving to townships). Moreover, while in the 11th- 12th centuries, population grew, peasants were in abundance and remuneration was at a minimum; the 13th-14th centuries experienced falls in the population due to famines and disease, labor shortages, and wage increases which led to a further weakening of the feudal subsystem.
Urban commune was the next newly emerging subsystem. Generally speaking, urban towns started from locations of weekly and permanent market places and trading ports, and expanded further. Historical estimates of the urbanization ratio (share of the population living in towns with more than 10000 inhabitants) show an average European ratio of 4,7% in the 10th century. The higher growth of the economy and population pushed the ratio upwards to 6,6% in the 14th century, with Italy at a highest ratio of 13,3%, cf. (Bairoch, Batou and Chevre, 1988). Back in the 10th century, town inhabitants in Northern Italy were the first to limit, regulate, and in some degree appropriate government for their town, which they did by establishing urban communes, also known as quasi-independent city-governments. In some sense, the urban communes can be viewed as the counterparts of the rural manors. Apart from the locational distinction, the two subsystems were completely different and rather opposites of each other in the way that they were formed and evolved. Rural manors were patron led, while urban communes were civil led, sworn associations of the inhabitants of a town, who in this way became true 'citizens', to defend and strengthen the rights of the town. Councils and parliaments were an integral part of the organization of the commune, which showed quite a high degree of participation in the making of decisions, cf. (Hyde, * 1973). By the middle of the twelfth century, almost all cities in Northern Italy were governed by more or less independent communes, and recognized as such by various 1 charters. City communes spread to France, Flanders and Netherlands, and later to most g European cities. City communes became gradually the standard form of local governance. In England, the spread of local governance was less forthcoming due to the 5 greater power of the monarch and knights at the national level. In time, the decentralized and centralized forms of governance at respectively the local and national levels evolved, changed and combined to form roots of the contemporary modern state settings and the state subsystem, S.
Trade guilds formed the other major subsystem that emerged in the period. The crusades required production and maintenance of transportation means on land and sea, f? costumes, metal weapons, and related tools, which meant an enhanced role for traders, o transporters and craftsmen and an emphasis on acquiring skills and training ^ apprentices. Merchant and occupational guilds came into being in these years. A trader ro handling his trade setting in isolation from other trade settings was in a weaker position E^ than when he was part of an established subsystem comprising other trade settings. 5. This would allow for property rights to be recognized and transaction costs to be £3 reduced. Against these benefits that accrue for the trading participants in the self- o organized subsystem, the trading participants complied with the conventionally ¡^ institutionalized codes of conduct; the same applied for craft guilds. The codes of conduct ^ included such directions as delivering the right goods, paying debt as agreed upon, g ensuring quality control, training apprentices, observing regulated prices, and f prohibiting free riding, cf. (Greif, 2006). As trade and travelling increased, road piracy E: increased. This prompted lords to employ armed guards for protecting traders, in exchange for fees; which set in motion the introduction of standardized currencies that
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14 The feudal subsystem gained additional strength in territories where the monarchy was forced by nobilities to step down from exercising absolute power, a case in point is the passing of the Magna Carta in England in 1215. The Papal manifesto and Magna Carta, are often quoted as exemplary for power consolidation of the Church and for the nobilities class respectively, but Q^
also as recognition of the over power of the monarch). O
propelled the exchange economy further. The trade and craft guilds formed the seeds of the firm subsystem, F, which became dominant in later centuries. Traders obtained additional pushes from enactment of commercial laws that increased trust among traders, institution of common means of payment, the reopening by the crusades of the Mediterranean to trade and travel (enabling Genoa and Venice to flourish as trading centers, and promoting the commercial motive of making some profit to keep their business running). Furthermore, the opening of the Mediterranean was a necessary preparatory phase for the age of discovery which came two centuries later, and was essential in expanding the F subsystem.
Summing up, leaders of behavioral settings of the same type, whether they belong to churches, manors, merchants, craftsmen or city notables tend to collaborate with their own counterparts and form a subsystem that regulates their intra- and interactions and protect their rights viz a viz outsiders. All settings of one type are better off when they are members of the subsystem that encompasses that type. Strictly speaking, a subsystem goes a step further if it formally establishes itself as one single juridical entity, and becomes lawfully recognized as such. In terms of institutional governance, already in the 12th-14th century the following juridical institutions were established: feudal laws, manor law, urban law, mercantile law pertaining respectively co to the subsystems of feudal-manor, urban communes, and merchant guilds.
3.3. The period of 1400 to 1700
Renaissance and the reformist revolutions. After reaching their climax in the 12th century, the grip of the Papal revolution and the supremacy of the supernatural began to diminish in the 13th century. Reliance upon absolute faith weakened. Gradually, interest in promises of the afterlife started shifting towards interest in the here and now. Besides, after a lengthy period of warfare and crusades and of cross-cultural interaction and fertilization, the Renaissance came in as age of peace and reflections. The Renaissance, or re-birth, began in Florence, Italy, a few decades before 1400, and spread
g later to the rest of Europe. Historians are flexible in defining the timing of this age, and <
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its character. Some analysts see it as the age of innovations in arts, music, literature, and poetry (producing Leonardo da Vinci, Michelangelo, Masaccio, Pisano, Dante, and their contemporaries in other European countries such as Shakespeare, Byrd, de 3 Montaigne, Mouton, among others). Other analysts emphasize intellectual pursuits as < the defining characters of the age, especially with regard to contributions to human, ! social, political philosophies, which significantly affected the courses of revolutionary events in Germany and England. There are other analysts who emphasize the ^ Renaissance's contributions to natural sciences which opened the way for scientific o discoveries and the industrial revolution a couple of centuries later. All these ^ contributions played major roles in articulating the social system and are relevant in the § context of the paper, as will be demonstrated below.
The renaissance brought about basic innovations in societal philosophies and contributed to revolutionary changes with lasting effects on the evolution of the socio-oj economic and political system in Europe. The two outstanding revolutionary changes in o this age were those of the protestant reformation and of the parliamentary democracy, which have been labelled by historians as the German revolution and the English ^ revolution (in contrast to the Papal revolution which was based in Italy). Before entering g into the events that led to the German and English revolutions, it fits to comment on the F rise of societal philosophies in the Renaissance. Sometime in the 13th century the influence of religious settings reached its climax and started diminishing quickly co thereafter with the advance of the Renaissance. Humanistic thought developed against a Christian backdrop. Humanism came in and challenged orthodox religious belief and o practices regarding restricted individual expression and suppression of the ego, self-<c abnegation and self-annihilation, and the unquestioning obedience to the church and o^ authorities. Instead, the renaissance propagated the creation of a universal man whose o person combined intellectual and physical excellence and who was capable of functioning
honorably, and elevated education and knowledge as basic instruments in nurturing humanism. Many of the Renaissance's foremost theologians were humanists, including Desiderius Erasmus, Martin Luther, and John Calvin. Other humanists like Niccolo Machiavelli, and Thomas More emphasized the virtues of intellectual freedom and individual expression. As political philosophers, they respectively sought to describe political life as it really was in terms of intrigues and non-transparences, and applied ideas of Greek and Roman democratic thinkers in critiques of their contemporary government. All these political thoughts were influential in shaping the German and English Revolutions.
Martin Luther can be said to have started the German revolution in 1517 by challenging ecclesiastical authority in the most radical terms. He demanded abolition of the ecclesiastical jurisdiction altogether, and denounced papal indulgences. Furthermore, he denied the validity of the canon law. An endnote gives a brief account of what happened15.
Along similar lines, Reformist Puritans led the English revolution. In 1640, they formed a majority in the parliament that was seldom convened, and they opposed the absolute reign of the monarch. The Puritans associated with John Calvin, who also denied the authority of the Roman church, as Luther did. Calvin differed from Luther in proponing that mankind acts always as God's agent in the unfolding of God's purposes ^ behind the creation, that the unfolding and reformation ought to be globally applicable ° to all places and peoples, and that the means of reformation ought to be through laws ^ and legislation. Puritans propagated that the right path requires practicing o communitarianism (each person is responsible for all, and all were responsible for each), embodying toughness (hard work, thrift, austerity, reliability, discipline, commitment), and that government be run by representative leaders of the community (elders and, magistrates and not a single ruler or multiple princes). The endnote here gives a brief * account of what happened16. iST
In short, the German and English revolutions, taken together, established 1 institutions that shifted political power to representatives of the population, emphasized g common law, abolished prerogative courts eliminated feudal tenures, prohibited arbitrary taxation, recognized property rights, and esteemed the individual's 5 responsibility and accountability for one's own actions-in short, the protestant ethic. Although these various elements belonged to the separate subsystems of political, legal, social and economic realms, they nevertheless fed each other, sought operative balances, and formed together a consistent whole that circumscribed the political, social and economic subsystems.
The impact of the German and English revolutions on the social system of the western world is enormous and fundamental. Max Weber was the first to propose that the acquired values of the protestant ethic were behind the takeoff of the European economy. Weber's thoughts, when paraphrased in terms of our conceptual framework, boils to formulating and accepting two statements: (a) that western society has acquired
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15 From (Berman, 1983): «No priest, Luther said, is authorized to come between God and the individual human soul that seeks forgiveness for sins. Therefore, no priest can promulgate the laws by which Christians should live. The Church, Luther said, has
no authority to declare laws at all. It is not a law making institution... Soon after, the ruling Emperor excommunicated Luther q
by imperial decree. In 1529, ruling princes and city representatives, in support of Luther, protested the imperial decree, and civil 3
war broke out. It is from this protest that the name Protestant is derived. The princes formed a religious party, the Protestant 0)
League, which in 1552, with the help of France, defeated the Emperor. Finally, in 1555, at Augsburg, a religious peace was made, whereby each of the various principalities of the Empire was empowered to establish its own form of religion, either Catholic or Protestant. In the years that followed the Papal position on supremacy of the Church was replaced by the strict O
separation of church from state in matters of jurisdiction and authority».
16 From (Berman, 1983): «A civil war broke out in 1640 between the Puritans (mostly reformist trading and craft guilds in towns and countryside) and supporters of the monarchy (conservative churchmen and landlords). The Puritans seized power,
formed a commonwealth government, trialed and executed King Charles I for treason and abuse of power in 1649... Ten years Z
later, the Puritan rule collapsed in 1658. The king's son, Charles II, was restored as monarch. When the next monarch, James II, resumed abuse of power, he was forced to abdicate and a new dynasty was installed in 1688. Henceforth, the governing authority was the parliament and not the king. The system of parliamentary political parties started taking shape and evolving to ^
what it is today. The Bill of Rights was enacted in 1689. Judges were given life tenure. With the abolition of the prerogative courts, the common law courts were recognized as subordinate only to Parliament. The content of the common law also changed, both in procedure and in substance». O
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the values of the reformist revolutions that associate with and foster productive work and maximum returns, as are typical of the firm centered behavioral type; and (b) somehow the firm based profit maximizing behaviour has invisible fingers and a universal validity that mold the other political, social and economic elements, or subsystems, into a consistent whole that reflects their newly acquired values. The first statement makes sense, is defendable, and we take it as part of our explanation for the emergence and growth of the firm subsystem in the European context. However, the second statement is dogmatic and not defendable. The different political, legal, social, and economic subsystems have their own mechanisms and outcomes; these adjust to each other and seek workable balances reflecting the relative strengths of the subsystems. There is no magical, hidden or rational nucleus that molds the whole system to one 'final destination'. If after hundreds of years of historical events and subsystem interactions we 'observe' today a firm-dominated system in Europe (and US), then this 'observation' is the result of the specific history of world development and the relative dominances of the interacting subsystems that occurred. The acquired values of the reformist revolutions did have a strengthening impact for firm settings in Europe, but there is no deterministic nucleus behind an evolution towards the currently observed FIS in Europe.
co World discoveries and the colonial conquest. The Renaissance was not only
o famous for its contributions to art, intellect, humanities, and polity matters but it was ™ also the eye-opener for geographical discoveries and the broadening of the worldview ^ during the 14th-17th century, as well as technological advances and the industrial - revolution in the 18th-19th century. This section considers the systemic impacts of the 5 geographic discoveries, a later section deals with the industrial revolution. Although the ° roots of the discovery age go back to the vikings, the crusaders, and the eye-openers of ® the Renaissance, the immediate need for explorations came from the war successes of ^ the Ottoman Empire in the Middle East and their ability to obstruct overland trade routes from Europe to the spice-growing Asian countries. In reaction to these barriers, governments and traders in Portugal and Spain started exploring new ocean routes to Asia. Political power and economic trade were major motivations. While succeeding in opening a southern trade route to Asia by sailing around Africa into the Indian Ocean; Spain and Portugal stumbled across the Americas. Soon after, the Dutch, British, and French followed, while Italian seaports and citizens played central roles in explorations and trade.
The discovery age and the colonial conquest, by themselves perhaps the greatest events in world development, have triggered fundamental changes in global relations and social systems. The collaborations between the governing authorities and overseas traders are especially relevant for our analysis. European monarchies sought greater powers in their countries via expanding colonial territorial possessions; which pushed more European monarchs to compete for the same political objective. Ultimately, the political objective served as the means to realize the desired and more commonly felt economic objective of bringing more material benefits from the colonial act. The politicoes economic collaboration meant that the monarch and the allied governing authorities o would mobilize recruited militaries and rely on established sea traders, shippers and craftsmen in realizing the colonization ventures and their material benefits. To that end, ^ and after the discovery of the Americas, colonial governments and traders in Europe g collaborated in the colonial acquisition of the territories, in mobilizing and transporting F migrants from Europe to the Americas, and in the production of agricultural commodities for exports to Europe against traded imports of goods from Europe. With co limited native populations in the colonies, the colonial governments and traders looked for other workforce sources: slaves. They began by battling and capturing African slaves, o and went later for buying African slaves from Afro-Arab capturers and sellers, < transported them and made them work on cotton and tobacco plantations in the o^ southern colonies of North America, and in mines and sugar-producing areas of Central o and South America.
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Triangular trade is the term used for describing this lucrative exchange between Europe, Africa and the Americas. Triangular trade involved three stages: Carry first such goods as cloth, spirit, tobacco, beads, metal goods, and guns from Europe to Africa. The goods were sold to Afro-Arab slave traders in exchange for more slaves. The guns were used to help expand empires and subjugate slaves. The second stage was an inhumane shipping of the slaves to the Americas. The third stage was the return to Europe with the produce from the slave-labor plantations: cotton, sugar, tobacco, molasses and rum.
To increase their income from taxing the triangular trade, European monarchs encouraged the formation of joint stock companies. Stocks (or shares) were sold to investors who shared the expense and risk of expensive ocean trading voyages. If a ship went down, no single investor lost everything, but if a voyage was successful, all stockholders shared in the profits. Most voyages succeeded, and many investors made good money. The British East India Company and the Dutch Verenigde Oost-Indische Compagnie, (VOC) established in 1600 and 1602, trading mostly with the Indian and Indonesian colonies, were the most successful ventures. Joint stock companies promoted the rise of the modern firm. Since governing monarchs chartered the joint stock companies of the colonial era, they were a form of state-sponsored firm ownership. This is a bright example of how the state subsystem was involved in strongly supporting (or ex-post, how the state was made to support) the firm subsystem.
Among the greatest impacts of the colonial conquest is the more than triplication, amply four centuries later, of the market size of Europe, by the addition of the market sizes of North America and other conquered European Commonwealth countries. The expanded markets meant that hence forth an abundance of opportunities for making profits were projected ahead. This stipulated triple expansion of the market place for trading and shipping firms was an unprecedented boost for the firm subsystem. • Although the period of discovery and colonial conquest raised the authority and strength ^ of the state subsystem to a highest level, this period prepared the ground for greater 1 gains for the firm subsystem in later periods. g
The rise of nation states and business metropolis were two other major world developments in the Middle Ages. Generally speaking, the state is a coordinated polity 5 system with geopolitical boundaries, while the nation implies a unified population along cultural, religious, linguistic and other related dimensions, territorially bounded. The term nation state implies that the two combine in one, and thus reinforce each other. There are thus varying degrees of the integrated nation state. In general, the longer that there is shared polity and history for a country the greater is the applicability of the notion nation state to the country. The rise of nation states in 1400-1700 boosted FT significantly the authority and strength of the state subsystem in Europe. While the 15 th o century in Europe started with powerful monarchs reigning on approximately defined ^ territories (advances in map-making technologies in the 15th century must have ro contributed to the drawing up of territorial borders and formation of nation states), ££ polity matters were not strongly connected in a coordinated whole (that is to say: royal S law, canon law, manorial law, communal law, commercial law, etc., did not form a £3 common law system). In the course of the 16th and 17th centuries and due to the o reformist revolutions in Germany and England, the systematization of polity coordination advanced significantly. The evolution of the bondage between a people and ^ the territory these people inhabit was also advanced appreciably. The German g revolution, being the result of confrontations between the established German f governance and German protesting leaders on behalf of millions of Germans in German ^ territories was a milestone in the development of the nation state of Germany. Similarly, the initiation of the English revolution, its accomplishments, and applications by the English people as citizens of the British Islands was another milestone in the o development of nation states. Historians also note the early emergence of a relatively < unified nation states, and a sense of common identity, in Portugal and in Spain as early q^ as the 15 th and 16th century, and in the Dutch Republic, which existed from 1581, when o
seven provinces of the Netherlands separated from Spanish rule and formed a union. The relative isolation of the Scandinavian countries in terms of distance contributed also to the early emergence of nation states in Scandinavia. Synchronization of the polity system in France had to wait longer: until the French revolution in 1789, and some years after. However, the spread of the French language as the mother language in France in the Renaissance contributed significantly to the gradual formation of the French nation. The nation state of Italy lagged behind17.
Other factors played important roles in the development of the nation state in different countries. The nation state gathered strength in the age of world discoveries and colonial conquests. It is not surprising that the earliest nation states of Portugal and Spain were the leaders of national interests and colonial conquest, followed by the Netherlands and England. Nationalistic attitudes favoring state hegemony received also a boost from the mercantilist thought which esteemed national protection in the conduction of foreign trade.
An equally important threshold was the rise of business metropolis18, which was basic for the evolution of the firm subsystem. A crucial development in the economic history of Europe was the major shift of economic power from the Mediterranean Sea to the North Sea, which went along with the creation of multi-purpose business metropolis co in the latter. The commercial cities of Genoa and Venice, which were forerunners of o urbanization in Europe in the 14th and 15th century, were replaced in the 16th and 17th ^ century by city ports that can be likened with business metropolis like Antwerp, Bruges ^ and Amsterdam in the Netherlands and Bristol, Liverpool and London in England.
- The shift of economic power and business centers from the southern to the
s northern countries has always been fascinating to study. It is sufficient to mention here ° what is thought to be the main factors behind the shift. On the negative side, the • fragmented governance of Italy delayed the phase of consolidation into a nation state, and thus forgoing its economic benefits; France was agricultural and still under influence of a significant feudal subsystem; while Spain and Portugal were preoccupied with defending their colonial conquest overseas. On the positive side, the Netherlands had the advantages of a puritan attitude towards work, obligation and property rights, an early adoption of the nation state, a densely populated small sized flat land, a favourable positioning as the mainland port to the north central part of the continent, accomplishments in innovative uses of water and wind for generating energy, and ability to increase productivity in shipping overseas and inland. By building the business metropolis the merchant class minimized the cost of exchanges (i.e search, negotiation, enforcement and financing costs). Search costs were reduced through first establishing regional market fairs that grew later to large scale permanent markets in Amsterdam. Commodity prices determined by supply and demand forces were gathered periodically and made public. The large volume of sales that took place resulted into conventional practices and norms that increased trust and reduced negotiation costs19. Enforcement costs of contracts were facilitated by public notaries; these were attached to the markets, and sanctioned by government. Another major breakthrough was the development of a ffi financial market that was driven for a part by fiscal borrowing needs of foreign o governments, France and Spain among others. The liquid business leaders were ready to ¡^ lend. Short-term and long-term depositing and lending to many sorts of customers grew ^ significantly, facilitated by establishment of banks and the legal right of transferring g and endorsing obligatory letters of payment to third parties. The reach of the business F metropolis went beyond trading and financing to art and culture. Urban merchants
17 It is paradoxical to note that while the first people and the first country to dominate Europe were the Romans who inhabited the Italian Peninsula, it was Italians and Italy who were among the last to form their nation state of Italy, in 1871; which was to 2 a great extent the result of the political and military engagement of Giuseppe Garibaldi (1807-1882), jointly with a few other
ll leaders.
^ 18 A business metropolis is a large city or urban area which is a significant economic, political, and cultural center for a country
< or region, and an important hub for regional or international connections, commerce, and communications. Although today the
^ term of metropolis is used for cities of millions, our use of the term to signal the urban agglomerations of city ports in the
ZD middle ages is justifiable time-wise and population-wise in relative terms.
^ 19 The advancement that took place in the Netherlands and England are discussed in (North, 1973. P. 136-137).
operated as in a modern outsourcing profit maximizing firms: the merchants contracted countryside workers, supplied the raw materials, fixed specified demands, and paid on fixed delivery, for activities ranging from fish catches and dairy products to tool forgery and cloth making20. Also on the positive side was England, being the earliest to share the puritan attitudes, to go for the nation state, to undergo a polity revolution, and to institute a House of Commons with a majority from the rising merchant class and landed gentry. England copied the successful business examples of the Dutch, became rivals on disputed colonies, and even went into war. The bigger size of England was decisive in making the colonial market fall in English hands, and turning England in the new number one business leader. While British farmers introduced newly domesticated crops, British entrepreneurs became major producers of cotton and woolen textiles, production primarily located in the countryside to escape guild regulations. The scale of production in heavy industry grew. Over the 17th century, England enacted a Statute of Monopolies, which ended the Crown's prerogative in creating monopolies, and created also the first patent law to encourage innovation. Networks of trade, industry and science were established, and financial markets were in operation in the capital and major cities.
Readdressing our question on how the S and F subsystems faired by the end of the 17th century, one obvious answer is that while both subsystems were building up ^ their constituent forces for the next round, in some countries the S subsystem was ahead ^ of the F subsystem. This applied for countries that have gone through the reformist ^ revolutions and had already more or less adopted that polity system which centuries o later converged towards the stable shape that is observable today. Considering also the -
side effects of the evolvement of the nation state, colonial conquest and mercantilist thought, it is logical to reason that in these instances the S subsystem was likely to have > been more dominant than the F subsystem, especially with regard to controlling ® influence, less so regarding interactive influence. However, there is no data on either regulatory influence or interactive influence to test the reasoning. As for the F 1 subsystem, in countries like England, Netherlands and a few others, the prerequisite g conditions for launching the F subsystem into its industrial orbit were present by the end of the 17 th century, waiting for the takeoff during the Industrial Revolution that was 5 due five decades later, when positions would start reversing and eventually place the firm subsystem above the state subsystem.
3.4. The period of 1700 to 1900
Enlightenment and the constitutional revolutions. The Enlightenment era (17001850) is held to be the source of democracy, rights, liberty and reason as primary values FT of society. Contributors to the Enlightenment era included political and legal o philosophers, economic and social thinkers, and natural and physical scientists. In this s section we comment briefly on the political enlightenment, where we emphasize the ro political dimension of western philosophy and rational thought, and which fed essential elements to the American and French constitutional revolutions, culminating in the o contemporary contours of the state subsystem. In the next section we focus on economic qj and scientific enlightenment that is closely aligned with the industrial revolution and o the firm subsystem.
The Political Enlightenment provided major elements of the political program, ^
adopted by leaders of the American and French revolutions years later. Montesquieu's g
Spirit of the Laws had expounded the theory of separation of powers; by placing the f
functions of legislation, executing, and judging in three wholly separate compartments, tz with legislation supreme over the other two. Montesquieu taught also that constitutional law should promote individual liberty and economic equality. Rousseau taught that law
should rectify inequalities that arise from natural differences among people. In his o
20 Although the urban cloth making craft guilds experienced a loss of monopoly, their interest was overpowered by merchant firms and government authorities, who took over and strengthened the city with a prosperous business community and a lively
< CC
cultural center. 2
Discourse on Inequality he proposed that inheritances ought to be reduced by taxes, and that those who owned no land receive some. Voltaire proposed substantial reforms of communal law. And for the first time, in the 1780's, 'public opinion' entered the arena as a separate dimension in determining the course of events. The Political Enlightenment era contributed groundwork principles for the American Declaration of Independence, the US Bill of Rights and the American Constitution, and the French Declaration of the Rights of Man and of the Citizen. These principles that have remained intact since then until present day, demarcate the authority and obligations of the state subsystem in western countries.
The historical facts are well known. The American Revolution (1775-1783) started with Thomas Jefferson's Declaration of Independence (which contained ideas from the Political Enlightenment), followed by establishing the independence of 13 North American colonies from Great Britain, creating the republic of USA, and enactment of the U.S. Constitution and the U.S. Bill of Rights, which contained articles that embodied the doctrine of the separation of powers, whereby the central polity is divided into the three branches of legislature (bicameral Congress), the executive (Presidential administration), and the judiciary (Supreme Court and other federal courts); the doctrine of federalism (describing the relationship between federal states co and between federal states and the central polity). The constitution included also o articles on its amendments, and various checks and balances on the powered authorities, ^ meant to assure restraint and accountability of the governing authorities to the ™ electorate. The U.S. Constitution was interpreted, supplemented, and implemented by a large body of constitutional law. Adopted in 1787, and amended on several occasions, in terms of world development, it was the first constitution of its kind, and had an inspiring impact on the constitutions of other nations.
At around the same time, 1789, the events of the French Revolution rolled21. In the decade after 1789 France was in a constant state of turmoil, as various revolutionary factions fought among themselves, and launched wars with neighboring countries. In 1799 France was ready for Napoleon Bonaparte's dictatorship. Some ten different
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constitutions replaced each other between 1789 and 1815. The French revolution
<
culminated with the establishment of a republican polity system, with supreme power given to a legislative assembly elected by popular vote and responsive to public opinion. | The church was subjected to state control insofar as that was necessary to protect < religious toleration. The judiciary was confined to the application of statutory law. Social g privileges of the aristocracy and feudal law were abolished, and equal civil rights were established for all. The legal system was transformed by unifying French law for all ^ French regions; and by codifying criminal, civil, and commercial law on a national scale. o In civil law, the enacted Code Civil (drafted by Napoleon in 1804) expressed the spirit of ^ the revolution, by bestowing strong protection to contracts and private property rights. ro Economic thought and the industrial revolution (IR). Technically speaking, the
IR began in Great Britain around 1760 and within a few decades spread to Western o- Europe and the United States. A first phase ending in 1840 converted hand production oj methods into mechanical ones, introduced new chemical manufacturing and iron o production processes, and developed machine tools. As regards energy, wood was ¡^ replaced by coal, steam power introduced, and water power improved. A second phase, ^ between 1840 and 1870, saw increasing adoption of steam-powered boats, ships, g railways and factories, and the large-scale production and use of machine tools.
o
03 21 Here are the historical events. The monarch in France in 1787 had absolute authority, limited symbolically by appellate courts
and the historical institution of the Estates General, the national assembly of representatives of the three estates (clergy, nobility, the Third Estate consisting of officials, lawyers, teachers, merchants, artisans, and others). Little revenues and luxury spending drove the crown to the verge of bankruptcy. An aristocracy that held to its privileges was confronted with hunger riots and <C peasant revolts. The Estates General, meeting at Versailles in May 1789-for the first time in 175 years, with sharp conflicts
^ between representatives of the clergy and nobility coalition and the Third Estate, ended with the Third Estate assuming full
ZD sovereign powers of the National Assembly. The storming of the Bastille was on the famous July 14, revolution started, and
^ monarchy fell. Subsequently, the old administrative and judicial authorities were dissolved, and the legal system was reformed.
00
At the advent of the IR many institutional ingredients for the pursuit of profit maximization in firm settings were already present in Europe (i.e. property rights, commercial law, distribution networks, and markets for products, labour and finance). Merchants, craftsmen, trading enterprises and cottage industry were abundant and active, though more so among the northern European (England and Netherlands) than among the southern European countries. Even though the prerequisites were present, yet the IR once started, it overturned the whole socio-economic system upside down. The IR fueled the creation of the profit maximizing firms as we know them today. The firm is hence a factory or a workshop that the risk-bearing owner/manager/entrepreneur sets up, and it is populated by hired regular employees who engage in the mechanical transformation of inputs into outputs (intermediate and final products). The outputs, scheduled for sale at stipulated prices by the owner, can end up in other prices, once subjected to market forces of demand by all consumers and market forces of supply by all producers. Such modes of production, distribution, pricing and clearance were realized through the IR. Economics, as a science, played a significant role in clarifying and supporting the rationale of the IR. Classical economists in 1776, i.e. Adam Smith, succeeded in specifying and knitting these different modes into a consistent static economic system in which consumers and producers pursuing utility maximization and profit maximization, respectively, and left to their own, would equalize their respective ^ demand and supply at variable prices in perfectly operating markets. The dynamics of ° the economic system emphasized that because the profit of the owner is the residual of ^ the market price less incurred labor, machine and material costs, the owner has to be o extra alert in his deals on costs and prices. Profitable and growing firms will generate incomes for employees that are then spent for new demands for goods that open opportunities for more entrepreneurs and new and more firms, and so on. The numbers of goods, firms and firm employees skyrocketed for many decades, and earnings kept on ® increasing since then. Although the degree of growth in these numbers fluctuated in the course of three centuries, a trend was started that would continue until present day, and 1 that would make profit maximizing firm settings as the most extensively spread and g most intensively populated subsystem in western countries. Classical economists highlighted the circular flow and the growth dynamics of a profit-maximizing firm- o driven economic system. Because profit rates tend to diminish as more competing firms enter into production, competing firms seek to innovate and widen the scope of production towards more goods with higher profit margins.
How did the household and state subsystems respond to the IR? Very important for our study was the change in the behavior of agents from a kinship sharing motivation typical of traditional household settings to a profit maximizing motivation FT typical of firm settings. Husbands and wives left their common dwellings on a massive o scale and worked as employee fullday in different firms. Child labour in yet another firm ^ was normal22. The break-up of the traditional family was definite and real. Scholars ro have called the phenomena estrangement. This is of course different from alienation S* that stands for the separation of the product from its maker, which is also a S revolutionary change brought about by the commercialization of the firm. The notions of qj a traditional household setting and of communal sharing were abruptly replaced by o loyalty to the employing firm. In time, the opportunity for employees to organize and ¡^ negotiate their demands with the employing firm would grow and be realized. Such ^ realization underlined the recognition of the mutual interests between employee and g employing firm and the common interest of both in advancing the sustained growth of f the firm. It would be some time before the working class developed a counter-ideology of E:
22 Children as young as four were put to employment. Youth performing the same work as elders earned 10% to 20% of an adult ll male's wage. Government tried to limit child labour by law, but factory owners resisted; In 1833 the first general laws against
child labour, the Factory Acts, were passed in Britain: Children younger than nine were not allowed to work, children were not <
permitted to work at night, and the work day of youth under the age of 18 was limited to twelve hours. Factory inspectors ^
supervised the execution of the law, however, their scarcity made enforcement difficult. About ten years later, the employment 3
of children and women in mining was forbidden. Gradually this was extended to all sectors. O
their own, and. became a social and political force of their own; though at a personal level, the employee always felt as part and parcel of the employing firm, and indirectly proponed and participated in the realization of the profit maximizing goal of the employing firm.
Economic thought played a significant role in justifying this new scheme of work and living, and made it the sensible path to follow for the employee layman and the firm owner alike. For example, economists treated the utility maximizing objective of consuming agents (measured in material terms) at par with the profit maximizing objective of firm owners and made the realization of the two objectives interdependent on each other. At the end of the day, the two objectives boiled to the same thing of retaining the highest benefit from a particular economic activity. Furthermore, the rationale for the profit maximizing motive gained ground as a result of economists laying down the interdependence at the firm level of rates of productivity, wage and profit. For the wage earner to earn more, it is in his interest that the firm increases productivity and pursues the profit maximizing objective.
How did the state subsystem, S, give way to the F subsystem during the IR? The greatest part of the newly created and produced goods during the IR was private goods, produced by profit maximizing private firms. Major public works were contracted to co private firms as well. The shares of private firms in terms of employed agents and o economic transformations overpowered the corresponding shares of the public sector. ^ Making use of the conceptual framework set out earlier in the paper, it can be stated ™ that the IR laid the basis for an edging interactive influence of the F subsystem over that of the S subsystem. What about the regulative influence of S on F? As the rest of this paragraph shows, economic thought on the IR dealt a crushing blow to the regulatory aspirations of the state. We may recall the support given by mercantilist thought to the regulatory powers of the nation state, in the 16th-17th century. That was a time when the controlling influence of the state reached a top. Not much later, mercantilist thought and the regulatory were shown to be economically inferior to free trade and competitive markets by the classical economists. Adam Smith, among others, built the rationale for
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the state to take a back seat and abstain from interventions in the free markets. The
message was: markets are able to regulate themselves and end up in satisfactory outcomes for their participants, when free of state intervention. Although the classical economists were aware of market failures which required state interventions, economic thought refining on issues of market failures is a later elaboration in time.
How did the F subsystem itself develop and expand further? There were subtle differences between the firm before the IR and after the IR. To mention a few: firms before the IR were mainly merchant firms, urban craftsmen, cottage workshops and the like, with some current capital but little fixed capital (the firm had minor tools and equipment). Firms of the IR were manufacturing factories requiring more current capital to finance pre-paid wages, and substantially much more fixed-sunk capital (premises, machines). The presence of financial firms (and financial markets) and the ability of entrepreneurs to obtain financial credit were crucial for launching the new oj firms. Because technically speaking the magnitudes of fixed-sunk capital would keep on o increasing at accelerated rates throughout future years, the financial component of the F ¡^ subsystem had to increase at accelerating rates as well. In passing, it is important to ^ add that if left uncontrolled, this accelerated tendency of the financial sector can result g in explosive risks. The conclusion to draw at this point is that economic thought laid F down the foundations for promoting the processes of the IR and the dominance of the t firm subsystem on other subsystems. Other subsystems have fused, lost intensity or co disappeared. By the end of the 18th century feudal manors and urban communes were ^ fused in the state subsystem, trade and craft guilds became part of the firm subsystem; o and theocratic settings seized to have significance in the economic system. <c It is relevant here to emphasize one major difference between the classical
cc economists (1700-1850) and neoclassical economists (1850 and later), which is crucial in o the development of the western economic system and for its study. While the attention of
the classical economists went to markets, the neoclassical economists brought the firm explicitly in the picture. Focus on firm settings and the firm subsystem is more instrumental for formulating and applying a conceptual framework for systemic analysis than referring to the notion of markets, which is a popular term but empirically is vaguely observable. The focus on firms as entities that can be observed and followed is a basic requirement for the better understanding of the functioning, growth and evolution of the economic system, and its relation to the whole social system. Besides, focus on firms has enriched our knowledge of the economic process and led to creating tens of firm related disciplines in economics and business.
3.5. The period of the 20th Century and recent years
The state subsystem in the western world, after going through the German, English, American and French constitutional revolutions, can be said to have reached its polity trajectory and satiation point already by 1820 or some two decades later. In relative terms, there has been little evolution in the polity structure of the S subsystem since then. Of course, state regulatory institutions evolved and changed, and so did state obligations and policies in the last two centuries; but the polity structure remained intact and appears to have reached a stabilized balance. The evolution is otherwise with the firm subsystem, which was totally revolutionized during the Industrial Revolution ^ (1750-1900), and has been undergoing important changes since then and up to the ° present day. The firm subsystem has not yet reached a long term stabilized balance, as ^ in the case of the state subsystem. o.
In the 20th century and later years, the following major events with significant systemic impacts can be singled out: two world wars (WWI and WWII), two great financial collapses (great depression 1929-1933 and great recession 2007-2009), and > several breakthroughs in political and economic western integration (NATO, EU, ® multinationals, and globalization). iST
Regarding the world wars, the causes of World War I (1914-1918) were rooted I deeply in the strengthening of Europe's nation states, or rather nationalist states, and g the forged alliances between camps of nation states. An assassination set off a ¡jf diplomatic crisis followed by a war declaration by Austria-Hungary on Serbia. Like a series of dominos, the other countries in Europe were pulled into a full war given their alliances to the two disputants, ending in Germany confronting and losing from France, UK and US on the west front, and Russia on the east front. WWI had important long-term consequences. The enormous cost of the war undermined the financial stability of all European countries involved and their state subsystems had to bear a burden of debt for many years to come. These financial losses, combined with the battlefield deaths and fT physical destruction, severely weakened the western front European powers, and pushed o US to become a world political power and the world's largest economy. On the east front ^ and one year after the war, the Russian Revolution replaced the czarist regime by ro communist rule. As for World War II (1939-1945), many historians see its causes in the enormous war indemnities and harsh terms of surrender that Germany had to accept o after WWI. In some sense, WWII was a revenge war against the outcome of WWI. The iS contra parties were the same as in WWI, except that this time Germany's allies included o Italy and Japan. The outcome in terms of gainers and losers was also the same as in ST WWI. The terms of peace were totally different, however. Instead of losers paying war ^ indemnities, the losers and gainers in Europe (and Japan) entered in a period of post- g war construction led by a close collaboration between states and firms; while the Soviet IT Union (with allied and/or subjugated east European countries) continued along its UTI communist track. TS
Turning to the economic upheavals, the Great depression (1929-1942), began in ^ the US and spread to most FIS countries. The «Roaring» twenties in US was a FO prosperous time that allowed excessive enrichment of some, inflated expectations of LA many, and fueled demand for financial credit, leading to a bull market and ending in a RN bursting speculative bubble in October 1929. The financial meltdown was followed by UO
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the longest recession in modern times. By early 1932 banks failed massively, wiping out the savings of millions of Americans. Unemployment reached 25% at a time when unemployment benefits did not exist. Mortgages on many homes and farms were foreclosed. Furthermore, a severe drought spread across the Great Plains in 1930 and lasted for a decade. Recovery started with the election of President Roosevelt (his New Deal introduced programs to reduce unemployment, assist firms, regulate banking and the Stock Market, and help the needy). With the outbreak of World War II in 1939, the U.S. began spending on armament and other war expenses materials, which further strengthened a period of industrial growth. The event of the Great Depression allowed the Federal Government to expand its domain to meeting collective needs in social welfare, and regulate the financial market. In the early thirties, regulations were introduced to restrict stock purchase on margin and coordinate risk taking in banking; in the hopes that another severe crash could never happen again.
But history replayed itself some 75 years later, though less severely. The financial crises 2007-2009, which started in US in 2007, took the proportions of a financial meltdown in late 2008, and spread globally to other linked financial markets economies, bringing them into economic recession in 2008 and 2009. The main cause is an overexpansion of lending activities that started from 2001 much beyond the ability of co borrowers to meet obligations to pay back (the unregulated shadow market in US o reached a worth of US$ 50 to 60 trillion). The overexpansion was facilitated by the use of ^ highly risky, undisclosed and complex newly introduced financial products and credit ^ default swap insurance contracts that defy monitoring and regulation. The relaxed attitude towards regulation by the state central bankers allowed dubious transactions to s expand unchecked. Credit default by homeowners in subprime mortgages in US in mid° 2007 triggered much bigger defaults among the mortgage lenders who were borrowers ® from other higher-up lenders, and so forth upwards. Speculative short selling on the expectation that security prices would fall further caused more falls. It is in the nature of a credit crunch confronting bankers to spread to producers causing a decline in production, layouts, spending and eventually recession. In attempts to restore financial confidence and recover the economies from recession, state interventions in FIS countries ranged from temporary nationalisation of financial institutions to capital injections, and bailouts of troubled investment banks; next to massive stimulus spending in the economy to combat the recession.
How did the S and F subsystems fare with the impact of the two world wars, and the two financial collapses? The wars and postwar reconstructions extended significantly the scope of activities of the state subsystem, which were directly translated in a greater ^ regulative influence of S; only to be deregulated later on in 1980 s. As for the F o subsystem, although its production capacity was significantly damaged during the wars, s F gained foothold in the defense and technology industries which later opened the way ro for thousands of new products that F was destined to transform and supply. Besides, it was firms after all which were engaged in executing the postwar reconstruction. All in o- all, it is safe to say that for an additional gain in the regulative influence of S, say x, oj there was a gain of (1+y)x in the interactive influence of F. In contrast, the financial o crises brought to the foreground the vulnerability of FIS countries, as an economic ¡^ system that is prone to financial instability once leading financiers of the firm subsystem ^ decide that the future expectations for profit maximization are overrated. Recovery from g the economic recession that accompanies the financial crises is a collective need that can F be resolved by the state only. The solutions posed and implemented gave the state a t greater regulative influence on the banking sector and financial products; which can be co viewed as a win for S and a loss for F in the regulative sphere.
— The analysis can be refined at this point. There is a striking phenomena that has
o evolved over the last few decades in FIS countries and has become more actual, < significant, and relevant for the future prospects of FIS countries. Figuratively, the F cc subsystem can be described as to consist basically of two tribes with an uneasy o relationship with each other: these are the F- financials and the F-tangibles. The two
branches of the firm subsystem rely on each other to carry their business, but in general, the management of money carries more leverage than the transformation of tangibles, and mismanagement by the financials, even if it is small, can bring significant damage to the growth prospective of the tangibles. In times of financial crunch (2007-2009 and continued for more years, mostly at the discretion of financials), tangibles suffer most. There is a rationale for the F-tangibles to support a strict state regulatory regime of the F-financials, if the financials are not able to fix transparent rules of conduct for themselves that are also acceptable for those dealing with them. Tangibles have a long history of fighting monopolistic practices in their segment and they work closely with government and the judiciary to realize competitive markets. This is not yet the case with financials that associate with market failures in the related areas of imperfect governance, asymmetric information, risks and uncertainty. It is logical in these circumstances to view the state's regulatory control of the F-financials as win-win for both the state and F-tangibles, but a loss for the F-financials. One and the other is an indication of a possible split of common interests in the F subsystem.
Globalization. Another significant world development in the 20th century is the integration of the FIS countries into a consolidated firm intensive world subsystem. The integration of the western countries in one subsystem was pushed by and manifested in the world wars and the financial collapses experiences, next to recurring milder ^ economic cycles in which all FIS countries participated. In addition, there were several ° initiatives and developments that contributed to the strengthened integration of the ^ political and socio-economic systems of the FIS countries. The establishment of the o North Atlantic Treaty Organization (NATO), the Organization for Economic Cooperation and Development (OECD), and the European Union (EU) were major steps in the integration. Extension and harmonization of trade liberalisation policies under the auspices of the General Agreement on Tariffs and Trade (GATT) set into motion business ® forces that are eager to introduce more competition and secure mutual gains for the FIS countries as well as for other countries. The GATT initiatives gained momentum with 1 various rounds of mutual tariff cuts, reduction of non-tariff barriers, passing norms for g government purchases from firms, export and farm subsidies, and dumping practices. ^ Replacement of GATT by the World Trade Organisation (WTO) with additional tasks of liberalizing trade in services, settling trade disputes, and facilitating investment between member countries. All the above developments, together with higher mobility of capital, labour, knowledge, shared media, and interactive communications worldwide gave a big push to globalizing processes starting around mid-1980's that gave additional strength to state and business organizations.
Globalization affected the F and S subsystems in FIS countries in contrasting ways. It made it possible for multinational firms to increase their influence in their FIS countries and other countries worldwide. The enhanced competition among multinational firms has been also functional in keeping them alert and active in S maintaining their market shares. In contrast, globalization is bringing restrictive effects on the degrees of freedom exercised by states, as states are often compelled to consider S and negotiate the side effects of their actions on other countries. l2
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4. Concluding remarks ¡^
After presenting a conceptual framework for the analysis of the development of ^
the economic system as a systemic whole, the paper made partial use of this conceptual g
framework in reviewing the rise and growth of competing subsystems in the western f
world in the last ten centuries, in particular the state and firm subsystems. While fig. 1 tz
gave the timeline of historical epochs in which major shifts of influence occurred among cô
these subsystems and others, fig. 2 sums up plausible magnitudes that reflect past ^
changes in the relative dominance of these subsystems. This figure approximates the o
western world by a square plane and the size of agent participation in subsystems by <
enclosed brackets. The figure gives configurations showing which subsystem was cc
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dominant in which epoch. For instance, in the early centuries, rural households occupied some 95% of the whole square plane. The birth of competing subsystems occurred in the 11th- 12th century. After reaching their peaks, from then onwards, agent activity in theocratic, feudal, royal and the traditional household subsystems declined, while firm and state subsystems increased. By the end of the 20th century the once dominant subsystems of traditional households, manorial, theocratic and royal settings have declined tremendously over time and can be guessed to command no more than 5% of the population, the state subsystem about 25%, and the firm subsystem about 70%. With a dominance of 70% in FIS centered countries, the F subsystem is able to spread its interactive influence and controlling influence to the whole system. The magnitude of the dominance would imply the conversion of the intrinsic motives of such subsystems as traditional households, manors, theocracy, royalty, and the state as well, into the intrinsic motive of the firm subsystem, i.e. profit maximization, is completed or near completion in the western world.
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Fig. 2. A stylization of relative magnitudes of major subsystems in FIS countries: Early
centuries to 21st Century Source: compiled by the author.
Would this past history of systemic development in the western world towards a firm intensive system apply to the future of economic systems in other parts of the world? It is possible but it is unlikely to happen for two reasons, which were mentioned earlier in the paper in a different context. First, the past history of the western world, as the past history of any other world region, and this would hold for their respective futures, are unique in that the starting points are different and the occurring events they face are of different substances and dimensions. Second, the idea that the profit motive and the firm subsystem, are capable of becoming the most dominant subsystem anywhere and have invisible fingers that automatically mold the social, political, legal, education subsystems, and what have you for subsystems, into a consistent whole manifesting the FIS is dogmatic and not defendable. Restating: there is no magical, hidden or rational nucleus that molds the whole system to one 'final destination'. If after hundreds of years of historical events and subsystem interactions we 'observe' today a firm-dominated system in Europe, then this 'observation' is the result of the specific history of world development and the relative dominances of the interacting subsystems that occurred. Hence, an observed systemic configuration cannot be described as deterministically given or as a final destination.
The above does not exclude the possibility that significant interactive and regularity influence of a powerful FIS oriented western world can impact other world ^ regions in the same direction. However, this influence is likely to be quite limited. Global 0 studies of the Dominance Index at the world level, see (Cohen, 2015), show that the DI in ^ 2012 of US, EU and related western economies is stuck at 39,4 percentage points, and is o predicted for 2030 to be at 30,6 percentage points (pp). DI for the world regions around China and India, that is East Asia Pacific (EAP), and South Asia (SA), respectively; amounted in 2012 to 21,5 pp and 13,3 pp, and are predicted in 2030 to score 25,0 pp and 15,0 pp, respectively; with the remaining percentage points for the rest of the world. At the world level, there seems to be no one world region (with its own distinctive economic system) that is big enough to dominate other world regions (and their related economic systems). Furthermore, the predictions show a decreasing relative influence of the FIS oriented western economies and rising influences of the other world regions.
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