Kuran & North on Institutions: Old Lessons for a New Egypt

Kuran & North on Institutions: Old Lessons for a New Egypt

November 21, 2019 1 By Kody Olson


North: Really what you mean I think by efficient
institutions is you have institutions that have low cost of transacting. You use the
word yourself in the opening part. By transaction costs we mean the costs of running an economic
system, that’s Ken Arrow’s definition and I like it. And presumably the lower the
costs for people to make exchanges and do things than the less resources you have to
use in that and therefore the more likely you are to be able to realize potential. And
indeed there’s a big tradeoff between lower transaction costs encouraging lower production
costs; which are the other half of the picture. And so what we have, therefore, when we have
efficient institutions is there institutions that enable us to make exchanges at lower
and lower costs of making the exchanges. Would that have satisfied your student? Kuran: I think so, I think she would have gone on to ask for some examples and I gave
her an example which I think fits in with the answer that you’ve just given; this
had to do with the medieval Mediterranean world where you had a number of different
legal systems that were available for merchants to use. At least in the part of the Mediterranean
that was then controlled by Muslims, there were of course the Islamic courts and there
were Islamic forms of exchange, Islamic partnership rules that were used by long distance traders,
but there were also the Jewish equivalent of these partnership forms, there were the
Christian equivalent and the non-Muslim minorities the Jews and the Christians living under Islamic
rule were perfectly free to use their own courts and to use their own forms of exchange
and forms of contracts if it so suited them. They were also free to use Islamic partnerships
and to take their disputes to the Islamic courts. At that time many non-Muslims were
preferring to use the Islamic courts. They were preferring to do long distance trade
under Islamic partnerships by forming Islamic partnership as opposed to Jewish partnerships.
Maimonides the famous Jewish philosopher who lived in Islamic Spain complains in one of
his books that the Jewish merchants of Spain were doing business in the manner of Gentiles.
What does he mean by this? The Gentiles to who he was referring to were the Arabs, the
Muslim Arabs of Spain. And what did he mean by doing business in the manner of the Gentiles?
He meant forming Islamic partnerships. Now why were the Jewish merchants when they could
have formed Jewish partnerships and used the Jewish courts, why were they doing business
in a different way? The reason is that Islamic partnership law offered flexibilities that
were very valuable to the merchants, Jewish partnership law required the financier, the
person who was putting up the money, and the traveling merchant, the one who went from
let’s say Spain to Cairo and back doing business, required them to share the profits
50/50. Whereas Islamic law gave the merchants and the financier the flexibility to set their
own profit ratio and depending on what they were going to trade and the reputation of
the merchant depending on the risks involved for the merchant they could set they could
change the share. So evidently this was valuable enough that the Jewish merchants were preferring
the Islamic to conduct their business by forming Islamic partnerships. Here is evidence that
the players themselves regardless of whether we as economists recognize what is efficient
and what is not the players themselves were are telling us that one of these institutional
forms was more efficient than the other. North: That’s a good starting point. I think
of transaction cost as the cost of measuring and enforcing agreements that sounds innocuous
but of course it’s not. By measurement you mean that all the attributes of an exchange
can be measured and if you can’t measure them then it’s very hard to make exchanges
because you don’t know what the value of whatever it is you are exchanging is. So measurement
and enforcement and flexibility of course of one of the things that lowers measurement
costs, if you have flexibility to do things in different ways. I suppose I want to ask
you back then if you’re an expert on the history of the Muslim world. I want to ask
you. Kuran: Not quite an expert I’m still learning. North: Well you’re as much of an expert as we’ve got in this room friend. But I
want to ask you how then in a Muslim world would the fact that the state enforces or
creates and enforces the institutions would that make for inefficiency or efficiency in
the world you’re talking about in the Muslim world. I.e. would the state be interested
in efficiency and in that sense try to adjust Muslim law so that you would create institutions
that would do this or not? Kuran: Depends on the time period. In the
tenth eleventh and twelfth centuries when Islamic law, classical Islamic law what is
called the Sharia evolved the jurists who interpreted the Koran and the classical sources
of Islam formed classical Islamic law were very sensitive to the needs of merchants.
There is a very good reason for this because many of them were merchants themselves, or
many of them were investors. So they, the partnership law was developed by the Islamic
jurists in the tenth eleventh and twelfth centuries was the most advanced partnership
law for the time because it was created by merchants. And all these flexibilities were
introduced because they had obvious efficiency implications. However the Islamic law ceased
to be controlled by people with an interest in commerce. Eventually they became part of
the bureaucracy and they started living off of tax revenues, living off of arbitrary confiscations
and they lost that interest and that is one of the factors that contributed to the stagnation
of Islamic law at a time when European business law, European commercial law, European financial
institutions were evolving becoming more efficient nothing was changing in the Middle East.