The Third Pillar: How Markets and the State are Leaving Communities Behind

The problem in Montegrano, as Banfield argues, was the extreme distrust between villagers, their worry about losing relative social position if they helped someone else improve their lot, and their corrosive envy of those who did succeed. Given this attitude, anyone who undertook a public-spirited action felt they incurred the full costs of acting, would probably receive only a small part of the public benefits, and would feel diminished by the public benefits that went to others. As one teacher explained, not only was there little public spirit, but many people positively wanted to prevent others from getting ahead.18 Such public apathy explains why voluntary efforts to supply public services – for example, masons repairing the monastery – simply did not emerge.

There are a variety of reasons why these attitudes exist in communities. When economic opportunity is very limited, economic activity might be seen as zero-sum – your gain comes at the expense of mine. The problem is exacerbated when families are at risk of slipping in social status, from the barely self-sufficient but still respectable to the ‘deplorable’, who are dependent on others for subsistence. With few savings and little wealth, many peasants were just one hailstorm or one pig’s unfortunate death away from a winter of deprivation or worse. While families were willing to help one another tide over temporary misfortune, more general public spirit required a degree of comfort with their economic situation that they simply did not have. Given the difficulty of staying afloat economically, villagers’ focus was on providing for their immediate family rather than maintaining a broader public spirit.

This inward focus may actually do public harm. A common example of what Banfield calls ‘amoral familism’ is visible in many developing countries, where people keep their houses spotlessly clean, but unceremoniously dump the garbage collected inside on the street outside. The ultimately self-defeating effects of having unclean and unhygienic public spaces surrounding clean homes can only be explained by extreme public apathy, a fundamental characteristic of dysfunctional communities.

The state, despite being recognisably apathetic, distant, and nonfunctional itself, nevertheless dampened initiative in Montegrano. The faint hope that the government will dig a latrine, pave a road, or discipline school teachers can prevent the local population from organising to do so. In frontier towns in the United States, the community raised a barn or built a road itself, knowing there was no one else who would do it. In dysfunctional communities where the government is closer, the misplaced expectation that the ghost of the inefficient government will eventually appear and do the job crowds out what little private initiative there is.

WHEN DO COMMUNITIES WORK AND WHEN DO THEY NOT?

Communities can be fragile even without becoming dysfunctional. They tend to work best when they are small and have little competition. Community relationships are built when members have limited choices, both at a point in time and over time. Relationships, and thus communities, become more fragile when the available set of choices expands, as when communities grow or when the outside market starts offering more opportunities to community members. Communities can also distort decisions, reducing the incentives for individuals to move, change, or adapt. While this may be the right individual choice, when many members make such choices it can drag down a community.

Too Many Alternatives

Mitchell Petersen of Northwestern University and I were interested in uncovering the effects of the greater availability of potential financial partners on the strength of relationships.19 We examined the relationships between small firms and their banks. Small firms typically find it hard to get finance, and young small firms especially so. Most economic theories would suggest that in areas with greater bank competition, young small firms would be better off.

Interestingly, we did not find this. Instead, in areas in the United States served by fewer banks, and hence with a less competitive banking market, we found small young firms got more bank loans, and at lower interest rates than similar small young firms in areas with many more banks. Importantly, they also seemed to pay back for this help. As the young firms aged, the interest rate they paid on their borrowings moved up faster in areas with few banks, with older firms paying more in such areas than in areas with more competitive banks.

Why were banks more willing to help out young firms in areas where firms had less choice of banking partners? The answer seemed to be that they knew they could build stronger relationships. As in the community relationships described above, a banking relationship is based on give and take over time. Lending to untried young firms is costly because even a small loan requires a fair amount of due diligence by the banker, and the size of the loan does not allow the bank to recoup the cost of the effort invested quickly. Moreover, many small firms fail, adding further to the bank’s costs as such loans have to be written off. A bank therefore takes a chance on an untried young firm only if it is reasonably confident the firm will survive, grow, and give it more profitable business in the future.

In areas with many banks, a successful firm could always renege on its implicit promise to the bank that helped it early on, by replacing it with a new banking partner at better terms. In areas with few other banks, however, the successful firm would likely stay with its original banker because of the lack of choice, and thus would compensate the bank with additional profitable business for the risk the bank took when the firm was young. A bank in such an area, being more confident in the (forced) durability of the relationship, would then be more eager to support young firms.

Thus, relationships seem to be stronger when the members of the community have fewer alternatives, for it gives the members confidence that they will stay mutually committed. An interesting corollary is that communities within a larger economy that are partially ostracised by others may flourish because members build stronger ties within the community. For instance, a disproportionate number of entrepreneurs during England’s Industrial Revolution were nonconformists such as Unitarians and Quakers, who were excluded from civil or military office and from Oxford or Cambridge University.20 The silver lining may have been that, given their exclusion from the larger community, nonconformists trusted one another more to continue maintaining business ties, with marriages eventually cementing the community links that provided initial business finance and business partners. Not only was entrepreneurship one of the few attractive career outlets that was not proscribed to capable Quaker youth, many a budding entrepreneur got help from others in the community as he started out.

In sum, in a small community, not only am I assured that those I help will stay committed to me, but I also know if I don’t help someone in deep trouble, my community may shrink and leave me worse off. In a small community, therefore, everyone has a stake in everyone else’s well-being. We are spoiled for choice as the community grows, which could hurt the community.21

Relationships also work better if partners interact over multiple activities – if one’s neighbour is not just a source of the odd gardening tool but also helps deliver our child, we are likely to have stronger bonds. However, this requires the community not to have specialists, else most of us would prefer our child be delivered by a professional midwife or gynecologist. There is no point specialising as a midwife if one is to serve a community with only a handful of women of childbearing age, but it makes more sense if there are hundreds – as Adam Smith famously wrote, ‘the division of labour is limited by the extent of the market’. As the community grows larger, therefore, we can call the professional midwife when a child is being born and the professional fire service when a cat is stuck up a tree, instead of our neighbour. Members have more choice, and the quality of goods and services they have access to increases, but the breadth of interactions that take place between members narrows. This social distancing or alienation once again diminishes the strength of relationships and the value of community.

Members could try to preserve a sense of community as it grows larger and more anonymous, urging everyone to take into account community benefits in deciding whether to transact locally or in the larger marketplace. They then run into the free-rider problem. We may all benefit from having a local bookstore, where we can browse through books before buying, and meet for coffee or for book events. It may well be that the associated benefits of building community through purchases from the local bookstore outweigh the lower price from ordering more cheaply online. However, if everyone else does their purchasing locally, the bookstore survives, leaving me free to cheat and patronise the cheaper online bookseller. The anonymity of a larger community will make individual transactions harder to police. When everyone acts in a rational self-interested way, the neighbourhood bookstore closes down, to the detriment of all.

Too Little Incentive to Change

We have just seen that self-interested people do not take into account the loss of benefits to community health when they transact outside the community. Equally problematic is when they rely overly on community support when they make individual decisions, staying too long within the community when the outside makes more sense. One situation where such incentives may be at work is when an important source of livelihood in the community is threatened by technological change or trade. A well-documented tragedy of the Industrial Revolution in England is the fate of the handloom weavers.22

The automation of spinning toward the end of the eighteenth century meant that there was much more yarn available to be woven. Automated power looms were only slowly being introduced, so there was strong demand for the labour of handloom weavers to weave the now abundantly available yarn into cloth. Unfortunately, the writing was on the wall – these jobs would be automated also. Indeed, because it was costly to let expensive power looms lie idle, the handloom weavers were already the first to be deprived of work when business slowed. Nevertheless, even as wages in handloom weaving fell as automation and the entry of workers created a labour surplus, the numbers joining the handloom weaving sector continued to increase. Eventually many ended up unemployed and destitute. Why did so many workers continue to stay in, or join, an industry that was so clearly doomed?

We will see such behavior again in modern United States. The explanation cannot be disassociated from community. Handloom weaving meant following the traditional family occupation, staying at home in the village with family and community close by, and enjoying all the benefits of community support. Changing jobs would mean moving to a dirty slum in a town and working in a hot, noisy factory. For the individual household that moved, this would have also meant foregoing the support the community could offer, and essentially tearing up all the implicit claims they had on it. Staying, even if the likelihood of job loss was high, was made less unpleasant by the prospect of community support.

As the entire handloom weaving industry collapsed, though, the weaver communities were severely weakened and unable to provide the support that was expected of them. Destitute unemployed weavers were forced to petition for public support from the government, which never came – in fact, the Poor Act in England was reformed in 1832 to tighten the conditions of eligibility for public relief.23 While it would not be fair to place the entire burden of this tragedy on the community, it is reasonable to conclude that the presence of the community can distort the decisions of its individual members. When trade and technological change affect many members of the community, their suboptimal individual decisions can end up dragging the community down with them as they place too much of a burden on it.

THE COSTS OF INSULAR COMMUNITIES

Communities through history have understood how detrimental the free and unconstrained choices of their members can be to community survival. For much of history, this did not matter because people had few alternatives, and change was slow. At times of great change, however, communities have had to react. Some of their actions may have made the communities much less useful in promoting social well-being.

Take, for example, the problem of excess outside choice that we discussed earlier. Most obviously, communities can prohibit or restrict contacts between their members and the outside, especially if such contacts can infuse new and uncomfortable ideas or make members more economically independent of the community. As we will see in the next chapter, feudalism was an example of enforced community, and was perpetuated by severe restrictions on what people could do.

Such restrictions are not imposed solely to protect the community, they also protect the powerful in the community against challenge and the community from desirable change. Ellen Barry of the New York Times followed the travails of a group of women from the Nats community in Meerut, a few miles from New Delhi.24 During the wedding season, the community men worked as musicians in wedding bands, but begging was the traditional off-season occupation for the community. As India started exporting buffalo meat in large quantities, some women started to work in a nearby meat-processing factory, and earned considerably more than their husbands. With the women contributing to family finances, and reducing the extortionate stranglehold of moneylenders, the male elders of the caste, some of whom not coincidentally were moneylenders, struck back. They decreed that the women should stop work, ostensibly so that they would not be exposed to the sexual advances of outside men.

The real reason, Barry surmised, was that the women’s earnings had begun to undermine the existing order. When some of the women refused to obey the decree, they were ostracised by the community. Of course, when community members want to break free, ostracism may have little punitive effect, so it was followed by violence. The women were forced to appeal to the police and the judiciary to protect them, as well as to ensure their constitutional right to work. In older India, neither would the job opportunity have arisen nor would the legal system be open to helping them. Markets and the state do open up the community, reducing the extent to which it can become oppressive.

In addition to remaining small to build relationships, the community may also need to remain small if it is to share information effectively.25 Apart from the costs of foregone growth, information sharing has its downsides. The community can be very intrusive and cloying, poking its nose in members’ private affairs. Gossip can be helpful in straightening out aberrant behavior, but it can also be mean, hurtful, and intolerant of deviance from age-old traditions. Transparency can highlight budding problems, but those in the community fishbowl, naked to the view of all, may be civil in public while hiding seething resentment. By comparison, the anonymity of the city can be liberating, even though it distances us from social relationships.

The pressure in some communities to stay small and only transact internally can also come at some cost to the broader system. Medieval Chinese master craftsmen typically found apprentices within the family or the close-knit clan. In contrast, the guild system in Europe allowed masters to take on apprentices from almost anywhere, and apprentices, on becoming masters, similarly could move to their hometowns to set up their workshops. According to economic historians de la Croix, Doepke, and Mokyr, a consequence of the looser guild structure in Europe was that technical knowledge was shared widely, improved upon, and shared again.26 In contrast, it remained relatively stagnant when confined within the clan in China. They argue that this can explain the vast improvements in Europe between 1500 and 1750 in a variety of technical areas, such as watchmaking, relative to China. It is a lesson that we will take to modern times when we examine firms and patent rights later in the book.

Communities may also try and hold together by overemphasising traditions as the source of the community’s strengths. In doing so, the community risks making members suspicious of the choices presented by the modern world, allowing them to become trapped by the past. This is particularly problematic in matters of science. Economic historian Joel Mokyr argues that a major spur to the scientific discoveries in the seventeenth century was the realisation that Aristotle’s scientific observations were often wrong.27 Equally energizing for scientific progress was the comfort that contemporary scientists like Galileo, Newton, and Leibnitz had extended the boundaries of knowledge far beyond what was contained in the ancient texts, and there was nothing extraordinary or eternal about the classics. This led scholars to challenge old knowledge in every area, breaking from their earlier conformism. In contrast, centres of Islamic learning, perhaps to promote the commonality and thus cohesiveness of historic Islamic thought in a rapidly expanding and disparate community, turned their gaze backward. Islamic scholars, whose predecessors had kept scientific knowledge alive and expanding during Europe’s Dark Ages, started studying older Islamic texts to uncover their eternal verities, and contributed little to the progress of science from the thirteenth century onward.

CONCLUSION

Although communities can be supportive, they are effective in special circumstances. Either community members are socialised to be concerned about the greater utility of the community and its members relative to their own – typically true of groups that grow up together or are ethnically homogenous – or the community needs some surplus value (what economists term ‘rents’) embedded in relationships for members to find cooperation worthwhile. As we saw with banking relationships, arguably the most important problem the community faces is the centrifugal pull of the outside on community members – the competition that emanates from the outside world erodes rents within the community. Ideally, the community would offset that centrifugal pull by the centripetal attraction of the warmth of its relationships and the noncontractual support it provides. Indeed, the point of inclusive localism, as we will see, is to create enough benefits through proximity that the community can afford to be inclusive. Nevertheless, the human desire to protect its valuable relationships and to create new ones by limiting competition and the pull of the outside, will be a recurrent theme throughout the book.

PART I

HOW THE PILLARS EMERGED

There are ninety and nine who live and die

In want and hunger and cold

That one may live in luxury

And be wrapped in a silken fold

The ninety and nine in hovels bare

The one in a palace with riches rare…

And the one owns cities, and houses and lands,

And the ninety nine have empty hands.

PUBLISHED IN THE FARMERS’ ALLIANCE, JULY 31, 1889, AT THE TIME OF THE POPULIST REVOLT IN THE UNITED STATES

In the Introduction, we explored some of the benefits of the community, the third pillar in our narrative, and also saw some of its downsides. In the next four chapters, we go back in history to trace how the three pillars we see today emerged from the original single pillar, the community. We will see the functions of each pillar and the interrelationships between them when society was, arguably, simpler. This will help us understand our current challenges as we recognise in today’s problems echoes from history. Also, we will see that pillars waxed and waned in strength through history, creating disequilibria. Society eventually adapted to restore balance. As we face another period of disequilibrium today, history should give us some confidence that we will find answers.

We start in Chapter 1 with the archetypal medieval community, the European feudal manor. The most valuable asset at that time, land, was rarely sold, since it was tied to a family or clan rather than an individual, and land rights were based on customs that involved feudal rights and obligations rather than explicit ownership. Goods were largely exchanged within the manor. The lord of the manor governed the community, adjudicating disputes and meting out justice. Thus, for all practical purposes, the community also contained the other two pillars. We use the quintessential market transaction, debt, as a focal point, and trace how both the state and markets separated from the feudal community over time. We will also follow changing public and scholarly attitudes towards business and markets, and see they have not been static. Instead, they often mirrored the economic and political necessities of the time, as they do today.

With the rise of the nation state, the state pillar was in ascendance. We turn in Chapter 2 to the emerging nation-state in England, and see how competitive markets helped England solve a fundamental conundrum – how the state can obtain a monopoly of military power within the country, and yet give up its powers to act arbitrarily and outside the law. This is essential for markets to be confident that private property is protected. We will see the importance of an efficient commercially-minded gentry as well as independent businesspersons in aggregating power through Parliament and imposing constitutional checks on the monarchy. Once the state was constitutionally limited, the way was open for truly competitive markets – individuals no longer needed the anti-competitive feudal structures such as guilds that also served to protect them against the state. At the same time, both widely-held private property as well as competitive markets were necessary to create an independent private sector that could protect property and constrain the state. In sum, the constitutionally limited state freed markets and free markets limited the state.

Once the markets were free of the fear of expropriation by the state, they flourished. As we will see in Chapter 3, the market pillar was dominant as countries experienced the First Industrial Revolution but often to the detriment of the community. The fight for broader suffrage was, in many ways, a fight by the community for more democratic power, this time to protect labour, not just physical property. The empowered community then, through movements like those of the Populists and the Progressives in the United States around the turn of the nineteenth century, played its role in restoring the balance by pressing the state to keep markets competitive and opportunity alive for the many.

The democratic community may not always want markets. In Chapter 4, we will outline three situations when the community does not push for competitive markets – when market players or practices are deemed illegitimate and the state seems a better alternative, when the state is weak and the community is easily bribed to stay apathetic, and when neither the state nor the community offer people the capabilities and the support they need to participate in volatile, changing markets. For people to desire markets, an effective state together with an engaged community have to create mechanisms that will provide people the capabilities and support that will allow them to benefit from markets. We will see how the balance came together in the liberal market democracies that emerged across the developed world by the early twentieth century. We will cover a thousand years of the evolution of the pillars in four chapters – a little too fast for the historians, but just right for our purpose, which is to give a sense of what problems they solved.

History’s lessons are important. They will give us a sense of why each pillar matters and how the pillars fit together to produce the liberal market economy. Patterns of their interaction reproduce, not exactly but recognisably. Nevertheless, readers who want to jump ahead to recent times might skim through Part I and go to Part II, where we move quickly through the post World War II–era to explain the genesis of today’s problems. They could then come back to Part I for a historical perspective.