by Birgir T. Runolfsson Solvason


    Historical Analysis
    Rules, Institutions, and Social Institutions
    Institutional Theory
    Modern Institutional Theory
    Constitutional Economics
    Public Choice


      "What difference does the explicit incorporation of the institutional analysis make to the writing (and for that matter the reading) of economic history and of history in general? Writing history is constructing a coherent story of some facet of the human condition through time. Such a construction exists only in the human mind. We do not recreate the past; we construct stories about the past. But to be good history, the story must give a consistent, logical account and be constrained by the available evidence and the available theory. A brief answer to the question is that incorporating institutions into history allows us to tell a much better story than we otherwise could." (North 1990:154)

    The task in this chapter is to discuss, briefly, the general type of theoretical approach used in this study. My theoretical explanation of the rise and the decline of the Icelandic Commonwealth is founded in modern institutional analysis. My purpose is to explain the history of the Commonwealth, but in doing so I explain how institutions arose and changed during this period. In other words, I will be telling the institutional history of the Commonwealth, and not the history of any particular individuals or events. My approach is an institutional analysis of the medieval Icelandic experience.

    I claim in this chapter, as have several new schools of economists, that without institutional analysis economic theory is incomplete. In particular, I argue that without institutional analysis economics as perceived by mainstream economists cannot throw much light on history. The essence of doing proper empirical work is to explain how institutions are shaped and how they themselves shape the choices of agents.

    The chapter will give support to my argument by explaining the relation between institutional analysis and history. Next I explain what we refer to as "institutions" and 1"institutional theory." Finally, I discuss modern political economy, in particular, constitutional economics and public choice theory, since my approach is derived from these schools of analysis.


      "Institutions place history in a role central to theory. Central, because institutions require that we recognize that the set of constraints within which current choice-making occurs is derived from the past, and without understanding the way in which those constraints have evolved, we cannot understand the choice set existing today. The study of economic history should provide the economist with an understanding not only of what the current institutional constraints are but also of the past incremental process that led to those constraints. The economist will understand the bargaining strength of organized groups that determined the current institutional structure and hence be in the position to develop a far more relevant model of the significant constraints that then need to be incorporated in his/her current model." (North 1990:113)

    The significance of institutional analysis is best demonstrated in the role it plays in empirical work. One could even go as far as to say that without accounting for the role institutions play in every historical situation there would be no history. There would be no history of how the economy developed and how society evolved, there would only be the biographies of individuals and "freeze-frame" pictures of choices in different periods. What institutional theory and analysis adds to a historical study is a `window' of perception, through which we can understand why and how choices were made the way they were, and the consequences of those choices. By incorporating institutions into our study, we can begin to understand why an economy developed or regressed, or why a society was stable or unstable.

    Institutions allow us to tell an institutional history; a history with a continuum. The continuous development or incremental change in institutions allows us to connect periods of history together, learning both how institutions change and what consequences the institutional changes have on economy and society. We can understand how and why certain institutions came into place, whether as the result of an organized effort on the part of some or all members of that society, or as an unintended consequence of some behaviourial pattern. Institutions reveal the relation between the polity and the economy, and the way these influence and effect each other. Through the study of institutions and a historical analysis of them we understand why people constrain themselves in those particular ways and not some other way. Or, as North says:

      "Institutions provide the basis structure by which human beings throughout history have created order and attempted to reduce uncertainty in exchange. Together with the technology employed they determine transaction and production costs and hence the profitability and feasibility of engaging in economic activity; they connect the past with the present and the future so that history is largely incremental story of institutional evolution in which the historical performance of economies can only be understood as a part of a sequential story; and they are the key to understanding the interrelationship between the polity and the economy and the consequences of that interrelationship for economic growth (or stagnation and decline). (1990:114)

    The incorporation of institutional theory into historical analysis not only allows us to understand the role of institutions better, it allows us to understand history and theory better. Theoretical analysis gives us conception of history, it allows us to determine what the facts are and how to arrange them in sets so they make a coherent story. But the historical knowledge that we gain through theoretical analysis also allows us to theorize better. In the same sense that there is no history without theory, so it is that there is no theory without history.1   We have a circle; theory informs history, which in turn informs theory.

    It is not the purpose of institutional theory to replace orthodox price theory. In fact institutional theory should be thought of as complementary to price theory; without institutional analysis price theory is incomplete. The relation between the two is circular; institutional theory and price theory inform each other.


      "Institutions are a creation of human beings. They evolve and are altered by them; hence our theory must begin with the individual.... at the same time the constraints that institutions impose on individual choices are pervasive and the failure to appreciate the role that institutions play in the choice set is a fundamental stumbling block in the path of further development of the social sciences generally and of economics in particular" (North 1990:4).

    Modern institutional analysis is concerned with the role of institutions in economics. This new subdiscipline analyzes how and why institutions emerge, and how they evolve, change, and are comparable to each other. We now have to define what we take "institutions" to be, or how we define them.

    Institutions can be defined in several ways, distinguished mainly by how broad or narrow one's analytical needs are. A narrow definition might claim that institutions include all "physical" phenomena, such as the Federal Reserve System, the Congress, the courts, firms, museums, the United Nations, the state, etc. This definition would exclude all "non-physical" phenomena, such as morals, manners, culture, language, etc. A broad definition, on the other hand, would include all "physical" and "non-physical" phenomena, ranging from lighthouses to manners, as long as some routine or rule-following behaviour were involved.2

    Using this broader definition, which I adopt, it might be more proper to speak of "Social Institutions" rather than just "institutions." The term "social institutions" incorporates all institutions, whether economic or other, all rules, whether statutory law or morals, and all routine or rule-guided behaviour, whether cultural or personal rules are involved. This last part is the essence of the term; a social institution is any behaviour of an individual or individuals that is based on either a routine or rule-guidance. Under this broad definition the terms "rules," "institutions," and "social institutions," are interchangeable; they all refer to the same sort of behaviour. Having defined institutions, let us now turn to the question of why institutions matter for the study of economics.3


       "Institutions are the rules of the game in a society or more formally are the humanly devised constraints that shape human interaction. They provide the structure to all human exchange, whether political, social or economic. Institutional change therefore shapes the way societies evolve through time and hence is the key to understanding historical change." (North 1990:1)

    The best way to answer the above question of what "institutions" are, is to explain what the purpose of institutions are. Institutions are created through, or with the intention of providing, routine behaviour. They are intended to provide some certainty in an otherwise uncertain world, to provide stability. In providing stability, institutions allow an individual to either adopt or refrain from certain form of behaviour and to allow the other individuals to form expectations about her behaviour. Without institutions individual behaviour would be chaotic; without routine expectations would be hard or impossible to form.4

    Individuals want stability to be able to form expectations of how other people will or will not behave. To get this stability they are willing to constrain themselves or be constrained. It is the task of institutional theory to analyze how individuals constrain themselves, how institutions emerge, evolve, and change, and how they compare with alternative institutions, whether former institutions or imagined ones. Understanding how people constrain themselves and how they might alternatively do so, helps us understand why their choices are what they are and how they could be under different institutional arrangements. Orthodox economic theory teaches us how individuals, under given constraints, make choices. Adding institutional theory to the orthodox theory, teaches us how choices will differ depending on the institutional arrangement. Institutional theory and orthodox theory are complementary, and together they help the economist answer criticisms from other disciplines, claiming that economic theory only holds in a certain institutional environment. As North states:

      "Defining institutions as the constraints that human beings impose on themselves makes the definition complementary to the choice theoretic approach of the neo-classical economic theory. Building a theory of institutions on the foundation of individual choice is a step towards reconciling differences between economics and the other social sciences." (1990:3)


    Modern Political Economy is a new subdiscipline within economics. It is actually a broad field of study that incorporates rather diverse schools of thought. Over the past several decades a whole array of schools within economics have appeared. These schools have gone under various labels, including: Public Choice, Property Rights School, Transaction Costs Economics, the New Economic History, Law and Economics, and Constitutional Economics. Sometimes more broadly encompassing labels have been used, such as Institutional Economics, New Institutional Economics, New Political Economy, Constitutional Political Economy, and Neoinstitutional Economics.

    Modern Political Economy may, on the other hand, be said to originate in the works of the Scottish Moral Philosophers and particularly in the work of Adam Smith. As Buchanan says:

      Constitutional political economy is best interpreted as a re-emphasis, a revival, a re-discovery, of basic elements of earlier intellectual traditions that have been set aside, neglected, and sometimes forgotten in the social sciences and social philosophy (1990:10).5

    Despite differing and sometimes conflicting labels, all of these schools of thought, which we in sum have called the Modern Political Economy, are alike concerned with the role of institutions in economics. In one way or another, all try to explain why and how institutions and rules emerge, and how they evolve, change, and are comparable with each other. Except for the "Old" Institutional school, all schools incorporate the rational choice model or homo economicus into their analysis.6 Yet, though the task of the various schools is for the most part similar and the schools' paradigms incorporate the same hard core principles, there are notable differences. Some, such as the Property Rights School, focus more narrowly on the institutions of property, and others, such as the Transactions Costs school, more narrowly on the costliness of exchanges.7 Instead of a detailed discussion on each of these schools I will focus on two of these schools.


      There is a categorical distinction to be made between constitutional economics and non-constitutional, or ordinary, economics, a distinction in the ultimate behaviourial object of analytical attention. In one sense, all of economics is about choice, and about the varying and complex institutional arrangements within which individuals make choices among alternatives. In ordinary or orthodox economics, no matter how simple or complex, analysis is concentrated on choices made within constraints that are, themselves, imposed exogenously to the person or persons charged with making the choice.
      It is precisely at this critical point that constitutional economics, in its most inclusive definition, departs from the conventional framework of analysis. Constitutional economics directs analytical attention to the choice among constraints (Buchanan 1990:2-3).8

    Economics, especially the neoclassical tradition, focuses on the choices of individuals. These choices are postulated as being constrained in one way or another, such as by nature, budgets, prices, rules, and institutions. These constraints are taken as givens and individuals can only make choices within these boundaries. No attempt is made to explain why any of these constraints are there, nor is the question asked whether some of these constraints are determined or are there by choice. It seems absurd to the orthodox economist that people might actually choose to constrain their own behaviour and choices. Scarcity, according to orthodox economics, is the basis for choice, and overcoming scarcity is basically the motive for behaviour. The idea that people may actually choose to artificially increase the degree of scarcity has not found a place within orthodox economics.

    At this point Constitutional Economics enters the arena.9 Constitutional Economics focuses on how constraints come into being; how rules and institutions are chosen. As Buchanan says, in moving "beyond the models of orthodox economics....we observe that individuals do, in fact, choose their own constraints, at least to a degree and within limits" (1990:3). It is the task of Constitutional Economics to explain why and how individuals come to choose one institutional arrangement, rather than another: "The whole inquiry involves the study of rules, how these rules work and how rules might be chosen" (Buchanan 1990:2).

    Constitutional Economics does not claim that orthodox analysis is unimportant or useless, but rather that it is incomplete. Analyzing how individuals make choices within a given institutional setting is in a way a trivial study; explaining these choices and their results in different institutional settings, by comparison, is of real significance. The latter paradigm helps us understand why and how people come to adopt one set of rules and institutions rather than some other.


      Public choice can be defined as the economic study of nonmarket decision making, or simply the application of economics to political science. The subject matter of public choice is the same as that of political science.... The methodology of public choice is that of economics, however. The basic behaviourial postulate of public choice, as for economics, is that man is an egoistic, rational, utility maximizer. (Mueller 1989:2)

    Not only has orthodox economics confined itself to analyzing choice within given constraints, but, further, economics has traditionally focused on individual choice in a market setting. In such a setting individuals are constrained by budgets, prices, and other market institutions, and they make choices and exchange with each other on the basis of these monetary terms. What public choice adds to conventional economics is its focus on hampered markets and politics; in other words, non-market settings. The novelty of the public choice approach is that it asks us to view politics as a market setting; the political market. Instead of viewing politicians and bureaucrats as altruistic, it postulates that these actors have the same motives for behaviour as do actors in market settings. At the same time, it recognizes that the incentives for choices in a non-market or political market may differ from those in a market setting.

    Although public choice focuses on non-market and political market settings it does not intrude on the field of political science. Rather, it adds to the study of political science. Political science views politics as a conflict where one side or the other comes out on top. Public choice, like economics, emphasizes the cooperative element of politics, where actors exchange with each other. Instead of viewing a political outcome as a triumph for a particular group, public choice may look at the outcome as a cooperative solution, where most or all groups got something they wanted. Public choice can also analyze conflicts, as economics analyzes market rivalry.


    Together, public choice and constitutional economics, give us an alternative paradigm by which to study politics and other non-market settings. Together these analyses add to the field of economics by explaining how constraints come into being, how they work, how they change, and how they are comparable. The areas in which these emerging fields add to the inquiry are properly viewed as the extension of the economic paradigm. Constitutional Political Economy should also be viewed as necessary for a more complete analysis of the market and social order. Without the fields of Constitutional Economics and Public Choice, the question of how a market order comes into being, evolves, and declines may not be properly understood. More generally, with the addition of these fields, the study of how social order is possible and comes about may be more fruitfully answered.10

    The Constitutional Political Economy of the Icelandic Commonwealth is what this study is all about. The theory I construct in this study and then use to explain the institutional structure of medieval Iceland, falls squarely within the paradigms of Constitutional Economics and Public Choice.

    bibliography       chapter 2

    1 Theory here, of course, refers to institutional theory.
    2 There should be no need to underline the fact that in theory building, such as institutional theory, institutions are created as "ideal types", and the historian will analyze institutions as ideal types. "The characteristic mark of an `ideal type'...is that it implies some proposition concerning valuing and acting... When it refers to institutions, it implies that these institutions are products of uniform or similar ways of valuing and acting or that they influence valuing and acting in a uniform or similar way" (Mises 1957:316). "The service a definite ideal type renders to...the historian in his analysis of the past is dependent on the specific understanding that led to its construction. To question the usefulness of an ideal type for explaining a definite problem, one must criticize the mode of understanding involved" (Mises 1957:319) "Ideal types are expedients to simplify the treatment of the puzzling multiplicity and variety of human affairs. In employing them one must always be aware of the deficiencies of any kind of simplification" (Mises 1957:320). "In acting-in their daily routine, as well as in technology and therapeutics, and also in history-people employ `real types,' that is, class concepts distinguishing people or institutions according to neatly definable traits" (Mises 1957:315). "The simplest way to describe the relationship between the analytical social sciences (praxeology) and the various kinds of history is in terms of the respective parts they play with regard to the production and use of ideal-typical conceptual schemes. Briefly, the former produce and the latter use them. They are used, as it were, as a foil against which to hold `real events', so as to bring out particular properties of the latter by comparison" (Lachmann 1986:34) For an excellent discussion on the relation between ideal-types and rules (institutions), see Horwitz (1989).
    3 Although it is important that the reader know what I am referring to when I speak of institutions, my study, as such, is not concerned with arguing for one definition rather than another. Neither is my concern with why it is that individuals adopt routine and rule-following behavior, i.e. establishing institutions. I take it as a given that people establish institutions and my concern is how they do it, not why they do it. For those interested in pursuing this latter avenue should consult the following literature: Vanberg (1988;1989), Heiner (1983;1990), Schotter (1981), Langlois (1986), Hayek (1967;1973), Nelson and Winter (1982), Horwitz (1989), and Ullman-Margalit (1977). (There are actually several "why" questions. The first is why an individual is willing to follow rules himself, another is why he wants others to follow rules. The former question is dealt with in the literature listed above, while the latter will be discussed below.)
    4 This is the second "why" question, and the answer. For an excellent discussion of the role of institutions and rules, see Horwitz (1989) and Hayek (1973).
    5 "The subject matter is not new or novel, and it may be argued that `constitutional economics' is more closely related to the work of Adam Smith and the classical economists than its modern `non-constitutional' counterpart." (Buchanan 1987c:584)
    6 On the methodology of Constitutional Political Economy, see Brennan and Buchanan (1985). On the methodology of neoinstitutional economics, see Eggertsson (1990). On the different methodological approaches of the `Old' Institutionalist and the New, see Vanberg (1988).
    7 On these various schools see: Buchanan (1987c;1990) on constitutional economics, Mueller (1989) and Buchanan (1984) on public choice, Hodgson (1988) on institutional economics, Langlois (1986) and Schotter (1981) on new institutional economics, Eggertsson (1990) on neoinstitutional economics, North (1990) and North and Thomas (1973) on the new economic history, Alchian (1965), Demsetz (1967), Alchian and Demsetz (1973), Pejovich (1972), and Furubotn and Pejovich (1972) on the property rights school, and Coase (1960) and Posner (1981) on law and economics.
    8 Although Buchanan uses the terms Constitutional Economics and Constitutional Political Economy synchronously, which I do not, and in a `narrow' definition, i.e. seperating this school from the others mentioned above, he does allow for a more `wider' definition: "In continental Europe, the whole set of subdisciplines is included under the rubric `The New Political Economy'. Within this set we can place (1) Public Choice, from which Constitutional Economics emerged; (2) Economics of Property Rights; (3) Law and Economics or Economic Analysis of Law; (4) Political Economy of Regulation; (5) the New Institutional Economics, and (6) the new Economic History. Defined imperialistically, Constitutional Economics would parallel the inclusive term and embrace all of these programmes, since some attention is drawn in each case to the legal-political constraints within which economic and political agents choose. (Buchanan 1987c:586) By Constitutional Economics, I refer to this wider or imperialistic definition of the field. Constitutional Economics, for me, refers to all choices by agents at the constitutional or meta-rule level. I do seperate Public Choice theory from this and to me it refers to all choices, in non-market settings, within the constitutional or meta-rule constraints. Together, Constitutional Economics and Public Choice, I refer to as Constitutional Political Economy.
    9 "By both contrast and comparison, constitutional economic analysis attempts to explain the working properties of alternative sets of legal-institutional-constitutional rules that constrain the choices and activities of economic and political agents, the rules that define the framework within which the ordinary choices of economic and political agents are made. In this sense, constitutional economics involves a `higher' level of inquiry than orthodox economics; it must incorporate the results of the latter along with many less sophisticated subdisciplines." (Buchanan 1987c:585)
    10 "The major contribution of modern Public Choice, as a subdiscipline in its own right, has been that of endogenizing political decision-making. In its direct emphasis, public choice theory examines the political decision rules that exist with a view toward making some predictions about just what sort of tax institutions or tax instruments will emerge. Constitutional Economics, as an extended research programme that emerges from Public Choice, goes a step further and uses the inputs from both neoclassical economics and public choice theory to analyze how alternative political rules might generate differing tax rules." (Buchanan 1987c:587)

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