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Paper 2: Medieval Period lectureQ: “Non-violence   is   the   greatest   force   at   the disposal  of  mankind.  It  is  mightier  than  the mightiest  weapon  of  destruction  devised  by  the ingenuity of man.”? Mahatma Gandhi Is violence against a perceived injustice ever acceptable?

Cite    FIVE    different    authors    from:    Aristotle; Augustine;  Aquinas;  Salisbury;  Magna  Carta; Innocent III; Pope Gregory; Barbarossa; Martin Luther;  James  I;  Coke;  Paine;  Roosevelt;  MLK Jr; any from readerSkills:  Contextual analysis of historical events; Tracing origins of contemporary structures and ideas; Empathy;

The Economics of Money, Banking, and
Financial Markets
Twelfth Edition, Global Editions
Chapter 2
An Overview of the Financial
System
Copyright © 2019 Pearson Education, Ltd.
Preview
• This chapter presents an overview of the study of financial
markets and institutions.
Copyright © 2019 Pearson Education, Ltd.
Learning Objectives (1 of 2)
• Compare and contrast direct and indirect finance.
• Identify the structure and components of financial markets.
• List and describe the different types of financial market
instruments.
• Recognize the international dimensions of financial
markets.
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Learning Objectives (2 of 2)
• Summarize the roles of transaction costs, risk sharing, and
information costs as they relate to financial intermediaries.
• List and describe the different types of financial
intermediaries.
• Identify the reasons for and list the types of financial
market regulations.
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Function of Financial Markets (1 of 2)
• Performs the essential function of channeling funds from
economic players that have saved surplus funds to those
that have a shortage of funds
• Direct finance: borrowers borrow funds directly from
lenders in financial markets by selling them securities
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Function of Financial Markets (2 of 2)
• Promotes economic efficiency by producing an efficient
allocation of capital, which increases production
• Directly improve the well-being of consumers by allowing
them to time purchases better
u
1.IN fact, research has found that development of financial industry
contributes to economic growth. So finance can be important for the
economy as it promotes the efficiency in capital formation.
2. It allows consumption smoothing: basically people can borrow money and
repay the money gradually in the future. So they can enjoy their current level
of consumption.
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Figure 1 Flows of Funds Through the
Financial System
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Structure of Financial Markets (1 of 2)
• Debt and Equity Markets
– Debt instruments (maturity)
– Equities (dividends)
• Primary and Secondary Markets
– Investment banks underwrite securities in primary
markets.
– Brokers and dealers work in secondary markets.
Direct Finance: use securities.
Security categories:
1. Bond. promise fixed maturity and fixed (or a formula for the interest rate) interest
payment.
2. equity/stock: a small piece of ownership to the capital of the issuing corporation/
institution. Holders of shares of stock have claims to the future profits and assets of the
issuing corporation/institution.
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Tabbing the direct finance is way more
complicated than indrect finance (but it may be
cheaper for large corporations who do not want to
be exploited by banks.
First, such corporations need a helper, it is
investment banks.
Second, investment banks advise the
corporations to make the best decision in issuing
securities.
Third, the investment bank will underwrite the
issued securities, be it bonds or stocks.
Question: What is “underwrite”?
Investment banks will set an issuing price of the
new security, and help the issuing corporation to
sell the security to investors in the market and
promise the purchase all the unsold securities.
Structure of Financial Markets (2 of 2)
• Exchanges and Over-the-Counter (OTC) Markets:
– Exchanges: NYSE, Chicago Board of Trade
– OTC markets: Foreign exchange, Federal funds
• Money and Capital Markets:
– Money markets deal in short-term debt instruments
– Capital markets deal in longer-term debt and
equity instruments
Money markets: debt securities with less than 1 year of maturity.
capital market: stock securities, debt securities with more than 1 year of
maturity, and loans.
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Financial Market Instruments (1 of 2)
Table 1 Principal Money Market Instruments
Amount ($ billions, end of year)
Type of Instrument
1990
2000
2010
2016
U.S. Treasury bills
527
647
1,767
1,816
Negotiable bank certificates of deposit
(large denominations)
547
1,053
1,923
1,727
Commercial paper
558
1,602
1,058
885
Federal funds and security repurchase
agreements
372
1,197
3,598
3,778
Source: Federal Reserve Flow of Funds Accounts; http://www.federalreserve.gov
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Financial Market Instruments (2 of 2)
Table 2 Principal Capital Market Instruments
Amount ($ billions, end of year)
Type of Instrument
1990
2000
2010
2016
Corporate stocks (market value)
3,530
17,628
23,567
38,685
Residential mortgages
2,676
5,205
10,446
10,283
Corporate bonds
1,703
4,991
10,337
12,008
U.S. government securities (marketable
long-term)
2,340
3,171
7,405
12,064
U.S. government agency securities
1,446
4,345
7,598
8,531
State and local government bonds
957
1,139
2,961
3,030
Bank commercial loans
818
1,497
2,001
3,360
Consumer loans
811
1,728
2,647
3,765
Commercial and farm mortgages
838
1,276
2,450
2,850
Source: Federal Reserve Flow of Funds Accounts; http://www.federalreserve.gov
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Internationalization of Financial Markets
• Foreign Bonds: sold in a foreign country and denominated in
that country’s currency
• Eurobond: bond denominated in a currency other than that of
the country in which it is sold
• Eurocurrencies: foreign currencies deposited in banks outside
the home country
– Eurodollars: U.S. dollars deposited in foreign banks outside
the United States or in foreign branches of U.S. banks
• World Stock Markets:
– help finance corporations in the United States and the U.S.
federal government
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Function of Financial Intermediaries:
Indirect Finance (1 of 3)
• Lower transaction costs (time and money spent in carrying
out financial transactions)
– Economies of scale
– Liquidity services
• Reduce the exposure of investors to risk
– Risk sharing (asset transformation)
– Diversification
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Function of Financial Intermediaries:
Indirect Finance (2 of 3)
• Deal with asymmetric information problems:
– Adverse Selection (before the transaction): try to
avoid selecting the risky borrower by gathering
information about them
– Moral Hazard (after the transaction): ensure borrower
will not engage in activities that will prevent him/her to
repay the loan.
§ Sign a contract with restrictive covenants.
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Function of Financial Intermediaries:
Indirect Finance (3 of 3)
• Conclusion:
– Financial intermediaries allow “small” savers and
borrowers to benefit from the existence of financial
markets.
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Types of Financial Intermediaries (1 of 5)
Table 3 Primary Assets and Liabilities of Financial
Intermediaries
Type of Intermediary
Primary Liabilities
(Sources of Funds)
Primary Assets (Uses of Funds)
Depository institutions (banks)
Blank
Blank
Commercial banks
Deposits
Business and consumer loans,
mortgages, U.S. government
securities, and municipal bonds
Savings and loan associations
Deposits
Mortgages
Mutual savings banks
Deposits
Mortgages
Credit unions
Deposits
Consumer loans
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Types of Financial Intermediaries (2 of 5)
[Table 3 Continued]
Primary Liabilities
(Sources of Funds)
Primary Assets (Uses of Funds)
Contractual savings
institutions
Blank
Blank
Life insurance companies
Premiums from policies
Corporate bonds and mortgages
Fire and casualty insurance
companies
Premiums from policies
Municipal bonds, corporate bonds
and stock, and U.S. government
securities
Pension funds, government
retirement funds
Employer and employee
contributions
Corporate bonds and stock
Type of Intermediary
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Types of Financial Intermediaries (3 of 5)
[Table 3 Continued]
Type of Intermediary
Primary Liabilities
(Sources of Funds)
Primary Assets (Uses of Funds)
Investment intermediaries
Blank
Blank
Finance companies
Commercial paper, stocks,
bonds
Consumer and business loans
Mutual funds
Shares
Stocks, bonds
Money market mutual funds
Shares
Money market instruments
Hedge funds
Partnership participation
Stocks, bonds, loans, foreign
currencies, and many other assets
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Types of Financial Intermediaries (4 of 5)
Table 4 Primary Financial Intermediaries and Value of Their
Assets
Value of Assets ($ billions, end of year)
Type of Intermediary
Depository institutions (banks)
Commercial banks, savings and loans,
and mutual savings banks
1990
Blank
2000
Blank
2010
Blank
2016
Blank
4,744
7,687
12,821
16,834
217
441
876
1,238
Contractual savings institutions
Blank
Blank
Blank
Blank
Life insurance companies
1,367
3,136
5,168
6,764
533
866
1,361
1,908
1,619
4,423
6,614
9,099
820
2,290
4,779
6,103
Credit unions
Fire and casualty insurance companies
Pension funds (private)
State and local government retirement
funds
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Types of Financial Intermediaries (5 of 5)
[Table 4 Continued]
Value of Assets ($ billions, end of year)
Type of Intermediary
Investment intermediaries
1990
Blank
2000
Blank
2010
Blank
2016
Blank
Finance companies
612
1,140
1,589
1,385
Mutual funds
608
4,435
7,873
13,616
Money market mutual funds
493
1,812
2,755
2,728
Source: Federal Reserve Flow of Funds Accounts; https://www.federalreserve.gov/releases/z1/current/data.htm,
Tables L110, L114, L115, L116, L118, L120, L121, L122, L127.
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Regulation of the Financial System (1 of 4)
• To increase the information available to investors:
– Reduce adverse selection and moral hazard problems
– Reduce insider trading (SEC)
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Regulation of the Financial System (2 of 4)
• To ensure the soundness of financial intermediaries:
– Restrictions on entry (chartering process).
– Disclosure of information.
– Restrictions on assets and activities (control holding of
risky assets).
– Deposit Insurance (avoid bank runs).
– Limits on competition (mostly in the past):
§ Branching
§ Restrictions on interest rates
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Regulation of the Financial System (3 of 4)
Table 5 Principal Regulatory Agencies of the U.S. Financial
System
Regulatory Agency
Subject of Regulation
Nature of Regulations
Securities and Exchange
Commission (SEC)
Organized exchanges and
financial markets
Requires disclosure of information;
restricts insider trading
Commodities Futures Trading
Commission (CFTC)
Futures market exchanges
Regulates procedures for trading in
futures markets
Office of the Comptroller of the
Currency
Federally-chartered commercial
banks and thrift institutions
Charters and examines the books of
federally chartered commercial
banks and thrift institutions; imposes
restrictions on assets they can hold
National Credit Union Administration
(NCUA)
Federally-chartered credit unions
Charters and examines the books of
federally chartered credit unions and
imposes restrictions on assets they
can hold
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Regulation of the Financial System (4 of 4)
[Table 5 Continued]
Regulatory Agency
Subject of Regulation
Nature of Regulations
State banking and insurance
commissions
State-chartered depository
institutions and insurance
companies
Charter and examine the books of statechartered banks and insurance
companies, impose restrictions on assets
they
can hold, and impose restrictions on
branching
Federal Deposit Insurance
Corporation (FDIC)
Commercial banks, mutual
savings banks, savings
and loan associations
Provides insurance of up to $250,000 for
each depositor at a bank, examines the
books of insured banks, and imposes
restrictions on assets they can hold
Federal Reserve System
All depository institutions
Examines the books of commercial banks
and systemically important financial
institutions; sets reserve requirements for
all banks
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The Feudal Origins of the Western Legal Tradition
Cameron Harwick & Hilton Root
2020, Jahrbuch für die Ordnung von Wirtschaft und Gesellschaft (Ordo), 70(1): 3-20.
Abstract. This paper draws a distinction between ‘communitarian’ and ‘rationalist’ legal orders
on the basis of the implied political strategy. We argue that the West’s solution to the
paradox of governance – that a government strong enough to protect rights cannot itself be
restrained from violating those rights – originates in certain aspects of the feudal contract, a
confluence of aspects of communitarian Germanic law, which enshrined a contractual notion
of political authority, and rationalistic Roman law, which supported large-scale political
organization. We trace the tradition of strong but limited government to the conflict between
factions with an interest in these legal traditions – nobles and the crown, respectively – and
draw limited conclusions for legal development in non-Western contexts.
Keywords. Legal origins, Economic history, Institutions, Norms, European history
JEL Codes. K1, N90, P51
I. Introduction
The Paradox of Governance – how a government strong enough to protect its citizens against each
other can be restrained from itself infringing on its citizens’ rights – is one of the most persistent
problems of political philosophy. Something like a solution to the paradox, a strong-but-limited
state, has been managed only in Western Europe and its descendant states. This raises several
questions: first, how did Western Europe manage the feat, and second, can the solution be replicated
elsewhere?
We propose to focus specifically on legal and administrative systems as the result of norms
governing the relationship between a government and its citizens. By classifying such systems into
the broad categories of rationalist and communitarian law, we aim to shed light on the unique
trajectory of the Western legal tradition as an unlikely synthesis of elements of both, and to
highlight the role of the legal system in shaping political institutions. We then show both the
desirability and the difficulty of such a synthesis, and show how the development of the Western
legal tradition out of Roman and Germanic law, through feudal institutions, paved the way for
feasible strong-but-limited states.
1
Electronic copy available at: https://ssrn.com/abstract=3502955
II. Communitarian and Rationalist Law: An Overview
2.1. Analytical Approach
Scholarly frameworks for interpreting European statebuilding (e.g. Weber 1968; Ertman 1997;
North et al. 2009) have typically divided the population into elites and commoners, focused on the
struggles and strategies within the former group. Commoners, almost by definition, have a much
broader and less coherent set of interests than political elites, and are therefore limited by higher
coordination difficulties. This difficulty, the logic goes, creates space for political action by bettercoordinated political elites, and justifies a focus on them (Tullock 1971). Institutional change is thus
considered to be driven by the struggle among elite factions for the reins of governance.
In contrast to these approaches, we draw the dividing line differently: between a governing
class and a governed population, placing the bulk of “elites” on the side of the governed.1 Contrary
to a view of institutional change as a struggle among coequal elite factions, there was remarkably
little turnover in the identities of the governing and governed classes over the millennium following
the collapse of the Roman empire. The familial networks of Europe’s governing royalty remained
mostly separate from the networks of its governed nobility (Root 2017), with the king as the
nominal head, even as the balance of power between them ebbed and flowed.
Drawing the line this way allows us to focus on the norm that determines the response of
the population to efforts at political domination as the basis for our analysis. This response has
frequently been modeled as a collective action problem. Nevertheless, though coordination upon any
particular strategy may constitute a collective action problem, coordination in general does not.
Indeed, the existence of stable polities ipso facto indicates some form of coordination. This is the
problem of legitimacy: political domination depends, to some extent, on the active or passive
cooperation of the governed, and on their common knowledge as to which forms of domination will
elicit cooperation (cf. Johnson & Koyama 2019).
The two simplest strategies will be something like “resist domination” and “submit to
domination”. Both of these strategies are natural Schelling points in a political game, and both are
1
Though it does provide additional insights, our framework does not necessarily rule out a flat-elite view of
European statebuilding if the governed elites act as normative focal points among the broader governed
population.
2
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Nash equilibria.2 If you cannot count on your fellows to resist domination, there is no incentive for
you to go alone. Similarly, if your fellows are agreed to resist, there will be no rational incentive to
support a would-be dominating party.3 More complex “conditional submission” strategies will be
more difficult to coordinate upon, for reasons discussed below (see section 2.4). We therefore take
these two simple strategies as the basis for our taxonomy.
This norm, then – whether resistance, submission, or something in between – determines the
character of the legal system by shaping the problems it encounters in exercising political authority.
Returning to our two baseline cases, a resisting population reliably settles into a legal structure with
a particular set of characteristics that we will call communitarian (see the following subsection). On
the other hand, a submissive population has the potential to scale up to the point that the exercise of
political authority reliably takes on a different set of characteristics, which we will call rationalist, in
order to deal effectively with the problems arising from scale (section 2.3).4 In this context, the
emergence of the Western legal tradition is characterized by constant renegotiation between the two.
Confronted with the exigencies of governing a population employing one strategy or the other, the
governing class has less freedom to structure its administration than might otherwise be supposed.
We therefore turn to a taxonomy of the strategies of the population that shape the administrative
options of political authorities.
2.2. Communitarian Law
Communitarian law, the legal order resulting from a strategy of resistance, is by far the older of the
2
More generally, these strategies are also evolutionarily stable, meaning their stability and viability do not
depend on the rationally optimizing behavior of the agents who employ it.
3
A strategy of resistance does not have to imply realized costly behavior on the part of each member of the
resisting public; only that each member signals a willingness at some margin to bear the cost of resistance. The
more such people as a proportion of a population, the more credible the threat against would-be dominators,
and the fewer resistors will in fact have to bear any costs. On the credibility of such signals in light of the
incentive for preference falsification and the potential instability of the resulting equilibria, see Kuran (1995).
4
Similar dichotomies have been offered by numerous authors. Greif (1994)’s “collectivism” and
“individualism” are perhaps the most similar, though they govern strategies in a mercantile game
characterized by principal-agent problems where politics are very much in the background. Other more
explicitly political distinctions employed in a European context, such as Weber’s (1968) “patrimonialism” and
“bureaucracy” or Ertman’s (1997) “authoritarianism” and “constitutionalism”, refer specifically to variation
among post-Feudal European states. All of these latter distinctions, therefore, will be more or less orthogonal
to the rationalist-communitarian distinction.
3
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two. From the very beginning of human social organization, humans have been characterized by
resistance to domination and relatively egalitarian social structures (Boehm 1993). We will limit
ourselves, however, to more advanced societies characterized by impersonal (but not necessarily
monetary or commercial) exchange and heterogeneity in social status, and therefore some necessity
for regularized law (Harwick 2018).
The primary effect of a resistance strategy is to limit the potential for power differentials to
arise endogenously. This in turn limits the potential for political predation, but also prevents the
formation of strong centralized governing bodies. The scale of political organization under
communitarian law can sustain clan and tribal-based affiliations, but is inherently limited (Dunbar
& Sosis 2018), and is likely to fracture beyond a certain size (Bandy 2004). Confederations among
various populations may form – Rome fell at the hands of one such confederation – but states and
empires will not. There will, for this reason, be little provision of large-scale public goods such as
infrastructure or commercial law.
From the perspective of the modern developed world, communitarian law is typically
referred to as “custom”. It is often unwritten and implicit in a community’s practice, and generated
in response to particular internal conflicts in order to prevent them from tearing the community
apart. On the one hand, this limits any dissonance between law and practice. Communitarian law is
legitimated automatically, so to speak, and enforced through coordinated social pressure. It tends to
be personalistic, dealing with people on the basis of their status and identity, and to resolve conflicts
through consensus. Lacking the institutional capacity to raise taxes effectively, conflicts will generally
be mediated informally by respected community members rather than professional judges. On the
other hand, there will be no necessary congruence between the laws of separate communities, which
may engender conflict when they come into contact.
In developed commercial economies, though the broader polity is governed by a rationalist
framework, particular communities can nevertheless be governed by communitarian law. Examples
include religious communes (e.g. Oved 1988), kibbutzim (Ben-Rafael 1997), resource commons
(Ostrom 1990), and even firms (Miller 1992, ch. 10).
2.3. Rationalist law
Rationalist law, on the other hand, arises from the need to regularize and legitimize the
administration of the domination that becomes possible when the governed class employ a strategy
of submission, especially as the scale of political organization exceeds the feasible limits of
communitarian law. There are several legal innovations that facilitate the task of large-scale
4
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administration:
1. Recording the law in writing allows standardization of enforcement across communities, and
some economies of scale in the production of trained professional judges. Leaders in a
communitarian legal order may be illiterate; administrators of a rationalist order may not.
2. Rationalist legal systems can use more abstract categories in the application of the law.
Personalistic status will not necessarily be discarded as a legal concept, but it will of necessity be
less fine-grained than in a communitarian legal order (cf. Johnson & Koyama 2013). This allows
a wider scope for private action, simply because a bureaucracy cannot involve itself in its citizens’
lives to the same extent that the members of a single community can exercise oversight over
each other.
3. Compared with communitarian law, compliance relies more on direct compulsion administered
by professionals, and less on social pressure and peer monitoring. Law is not “automatically”
legitimated as in communitarian law, which allows for greater scope on the part of the sovereign
for making legal changes, but also on the part of the population for lawbreaking if the law does
not comport with internalized norms. If law and norms diverge sufficiently, destabilizing social
movements can even be possible.
The rationalization of law is close to the notion of state capacity, which as Johnson and Koyama
(2017) point out, is not, by itself, an unambiguously positive development.5 Compared to
communitarian law, the primary drawback to rationalist law is the difficulty in preventing a
governing body strong enough to hire professional judges and standardize the law from exploiting
that power for its own benefit. The expanded sphere of private action made possible with rationalist
law is a matter of administrative convenience; it is not a meaningful constraint on the governing
class’ discretion to appropriate rents and suppress competing sources of power. The sovereign in a
rationalist legal order, therefore, will find it difficult to make credible commitments, a fact which can
impede economic development (Acemoglu 2003).
Rationalization, political centralization, and increasing social scale are driven by external
(Turchin 2008) or internal (Zhao 2015) threats to the integrity of a community. Those states that
were able to organize themselves in a more rationalist way were able to marshal more resources and
prevail against less rationalistically ordered polities. Rome and China, for example, in the face of
5
“State capacity”, however, is defined in terms of outcomes (“the ability of a state to collect taxes, enforce law
and order, and provide public goods”) rather than as an independent feature. For this reason, depending on
the particular measure used, empirical work using it as an independent variable is therefore subject to the
Glaeser et al. (2004) critique. Legal rationalization, as an independent feature, avoids this critique.
5
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both pressures, both developed a highly rationalistic legal administration early in their history,
systems which endure in some form or another to the present day.
2.4. Intermediate Strategies
The respective advantages and drawbacks of rationalist and communitarian law suggest the
desirability of a synthesis: large-scale political organization, with safeguards against opportunistic
behavior by political authorities.6 And in principle, an intermediate strategy of conditional
submission would make such a legal order feasible. Under such a strategy, the population would
presumptively submit to political authority, but revert to resistance in the event that leaders abused
their authority in agreed upon ways. Because a rationalist legal order depends on domination not
being too costly, such a reversion, if sufficiently well-coordinated, would constitute a credible threat
against potential abuses of political power.
Conditional submission strategies, however, are more difficult to coordinate upon, for several
related reasons.
1. There are many separate categories of domination – economic, ideological, sexual, to name a few
broad categories – not all of which will coincide. Reducing domination along one dimension,
given intermediate levels of domination in others, may even entail increasing domination in
others; for example, the use of political power to keep down economic inequality.
2. In practice, therefore, the conditions that make up a coherent conditional strategy are likely to
be quite complex in their details, 7 and it will be difficult to create common knowledge in a large
population as to which forms of domination are legitimate and which are not. A strategy that
conditions its response on more information will be transmitted with less fidelity to peers and
progeny, and less credible as a threat in light of imperfect information.
3. In addition to informational difficulties, coordination upon complex strategies also faces strategic
difficulties. Complex strategies are contestable along more margins, opening the door to
opportunism and rent-seeking at the strategy-deciding stage. Even abstracting from (1) and (2),
6
Djankov et al’s (2003) Institutional Possibilities Frontier construction depicts this relationship with a convex
curve representing a tradeoff between private predation and public predation. Contra Djankov, however, the
argument in this section is that there is no automatic mechanism to move a society to a cost-minimum
intermediate position, and in fact the poles (corresponding to communitarian and rationalist law, respectively)
will be attractors on the curve.
7
The debate between the Federalists and the Anti-federalists during the ratification of the U.S. constitution
is an instructive illustration of this point.
6
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a simple and obviously suboptimal strategy may still be able to gather more assent than any
particular complex strategy, even if any complex strategy would be a Pareto-improvement over
the simple strategy.
A constitution can be thought of as a technology for coordinating upon complex strategies in order
to restrain discretionary overreach by political officials. However, the track record of constitutional
reform worldwide is mixed at best, and most outside a Western context have failed to meaningfully
affect strategies, coalitions, or the incidence of rent-seeking (de Vanssay & Spindler 1994). Because
legal norms govern the bargaining strategies among a network of concrete interest groups – in our
case, between the governing and the governed – it will be difficult for a constitution, or any topdown directed change, to reconfigure an existing network of interest groups and therefore to effect
meaningful changes in political strategies. In other words, because political strategies are embodied
in political practice, they are likely to be “sticky” and resistant to change except over long periods of
time. Where constitutions have been effective, they have been consonant with the structure of
existing interest groups and built upon norms already governing the interactions among them. But
constitutions themselves are neither necessary nor sufficient for this to occur.
It remains, then, to explain the success of the Western legal tradition as a strategy of
conditional submission resulting in a strong-but-limited state. Our argument is that this strategy
arose during the Feudal era in Europe as interest groups favoring the rationalist Roman law and
those favoring the communitarian Germanic law vied for influence and power, and eventually
settled into a stable institutional compromise. We document this process in the following section,
and conclude with a warning against overgeneralizing the results.
III. The Evolution of an Intermediate Strategy in Western Europe
3.1. The Bond of Fealty
Prior to the fall of Rome, the various Germanic tribes – the Saxons, Franks, Vandals, and Goths –
were all characterized by advanced communitarian legal systems. Law was customary and unwritten,
rights to land were held by families rather than individuals, and loyalty was owed to particular
leaders rather than to more abstract notions of law or state.
In the aftermath of their victory over Rome, these tribes found themselves tasked with the
governance of a people accustomed to a much more rationalistic legal system than their own.
Desiring to shore up their own legitimacy and power, Germanic kings across Europe took on the
trappings of Roman leadership, for example in issuing coins bearing their own likenesses (Duby
7
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1974; Ertman 1997: 41). Most importantly, they issued written law codes which – while Germanic
in substance – drew on categories from Roman law in exposition and organization.
One major substantive change, however, did accompany the codification of the law. Tasked
with administering large numbers of foreigners, it became necessary to explicitly define the
obligations between lord and vassal. Over time, this relationship came to be understood as a legal
bond rather than a bond of kinship; one with definite mutual obligations, as well as formal recourse
for violations. By the eleventh century it was commonly understood that in the event of a breach of
fealty, the vassal could legitimately leave his lord and seek a new one (Berman 1983: 305; Bloch
1961: 451, 464).8 By the same token, if the vassal did not provide military services when called upon,
or some equivalent value in money that commuted that obligation, he could forfeit his land and
privileges.
The debt of Western political philosophy to this development is obvious. Berman (1983:
309) points to the bond of fealty as the source of the conception of political authority as a contract
between ruler and ruled, a notion central to modern conceptions of democracy and one unique to
the European legal tradition. It was also distinct from both the Roman and the Germanic sources
upon which it built. Roman law was equivocal on the question of the obligations of and constraints
upon rulers – a question which would occupy later jurists of public law for nearly a millennium9 –
but on the whole it had a distinctly absolutist character. Traditional Germanic law, on the other
hand, had ill-defined notions of contract and formal obligation, making it difficult to ensure the
predictability necessary for larger scale public or private organization. Feudal law, in contrast to both,
emphasized individuals as autonomous bearers of rights and obligations. And although the
particular rights and obligations differed according to social and economic status, they attached to
individuals in their capacity as individuals, regardless of rank.
3.2. The Codex Justinianus and the Re-Rationalization of European Law
8
This was a key feature distinguishing European feudalism from, for example, Japanese feudalism, where “the
vassal’s submission was much more unilateral” and “the divine power of the Emperor remained outside the
structure of vassal engagements” (Bloch 1961: 452).
9
At various points the great Roman jurist Ulpian had declared both that “the sovereign is not bound by the
laws” (D.1.3.1) and that “it befits the majesty of the ruler to profess that he as emperor is bound by the
laws” (C.1.14.4) (Stein 1999: 59). While it is likely that Ulpian had intended the latter statement more as a
practical expedient than a principled limit on imperial authority, medieval jurists with communitarian
intuitions used it to give force to the feudal notion of mutual political obligation.
8
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Elements of Roman law had survived the fall of Rome in Canon law and, to a lesser extent, in the
codices of the various Germanic kings. But these were compilations based on particular needs, and
did not represent Roman law in its full development, which had been lost until the discovery of a
full copy of the Codex Justinianus around 1050, a complete and self-contained summary of the
Roman legal code commissioned by the Byzantine emperor Justinian in the 6th century.
At this time, property arrangements in feudal Europe were still recognizably Germanic.
Land holding was particularly inflexible. There was no distinction between ownership and
possession, rights were held to various specific uses of the land rather than to the land itself, and
because these rights were held by families rather than individuals, they could only be alienated with
the consent of heirs and other family members with an interest in the land. This inflexibility
inhibited the movement of land into the hands of those who could use it most productively. In
addition, the written law was predominantly concerned with lord-vassal relations. There was little
provision either for commoners, who had recourse to the courts of their local lord, or for merchants,
who had begun to establish their own independent courts.
With advances in social organization and the revival of commerce beginning to outpace the
still-mostly-Germanic legal system, the advantages of an internally consistent and commercially
oriented legal code over the traditional system were immediately obvious. Legal scholars across the
continent were impressed by the the highly refined distinctions of the Codex – for example, between
possession and ownership, or the obligations resulting from contracts versus torts – and they began
in short order to establish law schools to teach the Codex (Southern 1953).
As these universities were mainly established in urban centers, which were also centers of
commerce, legal learning and commercial development began to flourish in tandem. And because
such cities were largely self-governing, many adopted the Codex tout court, putting them at variance
with rural areas still largely governed by Germanic custom.
It was this heterogeneity across regions, in addition to more straightforward self-interest,
that led the kings of Europe to push a second wave of legal rationalization. From the early 1200s,
kings began to employ jurists trained in Roman law to augment their own legitimacy, and to codify
and standardize custom across their domains.
In a bid to weaken feudal lords, kings at this time also began to appropriate seigneurial
privileges and transform them into public functions. Most importantly, they established royal courts
for serfs and commoners, and staffed them with professional judges. Manorial courts were often
ineffectual, opaque, and slow, and were not provided for at all by feudal law, so royal courts extended
legal protection to many who had de facto been largely without recourse to that point. As early as the
9
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eleventh century, the Church was arguing on the basis of Canon law that the relationship between a
king and his subjects was governed by the duty of fealty no less than the relationship between a lord
and his vassals. In this way, the emergence of an autonomous legal profession as a source of
legitimacy diffused Roman law both through feudal structures and into the wider population, and
provided the scaffolding for the first steps toward equality before the law in a way that would not
have been possible had court systems remained the prerogative of feudal elites.10
At the same time, Roman law was hardly an unalloyed instrument of emancipation, as can
be seen most clearly in France, where legal rationalization proceeded furthest.11 One aspect of the
enhanced organizational ability provided for by Roman law was the organization of interest groups
into corporate bodies, such as guilds and nobility, whose rights and privileges were protected by law
(Root 1994: 165-68; North, et al. 2009: 69-71). The capitalization and sale of such privileges became
an important source of royal revenue in France and Spain (Ertman 1997).12 The crown, for its own
part, found Roman law useful in advancing absolutist legal theories and freeing itself from the
constraints of law and custom. A unified state was the most natural setting for the extension of
Roman law (Root 1994), and royal jurists employed its concepts to argue that the king was legibus
solutus – “above the law” – and absolute in his rights as is a dominus over his estate.
This pan-European push for Romanization and rationalization continued through the
seventeenth and eighteenth centuries, and – along with the diffusion of a common language of legal
scholarship – resulted in what could legitimately be called a general European legal tradition.13 Over
this period of time, the legal profession developed into a distinctive hub among the wider network
10
North et al. (2009) argue that equality before the law originates as a way of structuring and pacifying inter-
elite conflicts, and is later generalized to the masses. By contrast, this account draws attention to the fact that
certain rationalistic aspects of equality before the law were first extended to the masses by the expansion of
royal power, with the despotic excesses of legal rationalization held in check by the reaction of feudal elites.
See the following subsection.
11
Rationalization in this sense (i.e. the regularization of obligations under the law, where France excelled) is
distinct from bureaucratization (i.e. the professionalization of administration, where France notably lagged
England and Germany).
12
This practice was a major complaint of the revolutionaries in the French Revolution, and in fact did not
cease until the Code Napoléon supplanted France’s mix of Roman and feudal law.
13
This is not to diminish the variety in post-feudal European political organization. Much attention has been
focused on constitutional England versus absolutist France, for example. Even so, France and England have
much more in common than, say, England and Egypt, and it will be these commonalities upon which the
paper focuses.
10
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of elites, and as an epistemic community became a crucial independent source of legitimacy in
political struggles, despite the fact that local or national law in whatever form it was actually
practiced and enforced was not taught in any European law school until the eighteenth century.
Partly because of this persistent divergence between the theory and the practice of law, feudal
privileges continued to inform the political strategies of the nobility, who increasingly found
themselves at odds with kings over the latter’s use of Roman law to accumulate privileges formerly
resting with the nobility.
3.3. Parliaments and the Resurgence of Communitarianism
The push for Romanization in practice was an attempt to ground royal legitimacy in the support of
the people rather than the support of the nobles. The king was regarded by the nobles as a primus
inter pares, but by the people as vested with supernatural authority. In addition, collective action
barriers meant that any effort of the people to punish the king for malfeasance would be
prohibitively difficult compared to the less numerous and better organized nobles. It is obvious why
kings would prefer to establish their power on the basis of a relationship with the people, as well as
why De Toqueville (1955) would argue that the nobility were the source of constraints on the
sovereign.
Beginning in the 12th century in Southern Europe and moving northward in the 13th and
14th centuries (Van Zanden, et al. 2012), and proceeding in tandem with the royal push toward
rationalization, nobles across the continent were able to take advantage of organizational advances in
Roman law and constitute themselves into relatively permanent bodies with control over the raising
of revenues for the crown. In the late 13th century, these parliamentary bodies were extended to
include representatives of the cities, in recognition of their increasing wealth and influence following
the post-Codex flourishing of commerce. By using their ability to levy taxes as a bargaining chip,
parliaments were able – with varying success – to push back against Romanization and to safeguard
their own privileges. Where the crown was able to secure an independent source of revenue, as in
Spain and France, rationalization and Romanization could proceed relatively unchecked. But where
fiscal necessity outstripped the king’s means, as in England and the Netherlands, the nobles were
able to effectively preserve the political strategies that had developed during the feudal era and that
regarded political authority as essentially contractual.
With the main power of these nascent parliaments being over the raising of revenue, many
found it necessary to ally with commercial interests. Mercantile participation in these parliaments
accustomed them to employ the conditional submission strategy developed by the nobility in the
11
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feudal era. In submission, the towns agreed to levy substantial taxes for the crown. But they were
also able to force concessions important to the advancement of commerce, such as forbearing to
debase the coinage, and more widespread protection of property rights. As Marongiu & Woolf
(1968: 233) note, “in the age of absolutism, the assemblies found the strength to survive through the
deep-rooted belief in the contractual nature of agreements between sovereigns and their peoples or
estates.”
Especially in Northern Europe, where fiscal pressures and a lack of alternative revenue
sources forced kings to call parliaments regularly, the effective restraint on royal discretion provided
by parliament allowed kings – ironically – to marshal far greater fiscal resources than was possible
under more successfully absolutist kings such as in France (cf. North & Weingast 1989). Towns and
nobles, having received assurances that their rights were protected, were able to collect far more tax
revenue than the crown’s own administration would have been capable of (Meyerson 2008). And
moneylenders, assured that parliament would require the king to repay his debts, lent willingly and
without the compulsion that was regularly employed by French kings (Root 1989; Veitch 1986).
Concurrent with the royal push for Romanization and the noble reaction, many jurists were
also able to make cogent arguments for communitarian interests from Roman principles: not only
for the rights and privileges of the nobles, but also for a sovereign constrained by law, or the holding
of political authority in trust from the people. Thus armed, noble and commercial interests could
oppose the crown not only on the basis of interest and power, but also on principle. By the 17th
century, the interplay between parliaments and kings in Northern Europe, and especially in
England, had evolved into an effectively constrained government, kept in check by (1) internal
divisions within the governing class, (2) a widespread conception of political authority as
contractual, which gave force to the punishment mechanisms embodied in parliament, and (3) a
jurisprudence of limited government arising out of juristic debate on public law. This arrangement
was further codified and rationalized in the United States, which had no nobles, but was able to
emulate the internal divisions of the governing class by explicitly structuring the government into
legislative, executive, and judicial branches.
Outside of Northern Europe and its successor states, much of the rest of Europe lagged
behind these developments both economically and institutionally. An effectively organized
resistance to full Romanization was far from inevitable: in many places, especially in Southern
Europe, the sovereign was able to successfully suppress parliaments, leading to a “little divergence” in
both economic growth and institutional quality (de Pleijt & van Zanden 2016). Nevertheless, the
varying strength and coherence of this reaction – though leading to significant variety in European
12
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legal and political institutions – is a relatively superficial difference compared to the common legal
tradition and (therefore) the conditional political strategy employed across the European continent,
diffused more through the spread of an autonomous legal profession than successful resistance. The
relative success of strong-but-limited governments in South and Central Europe following the two
World Wars, and in Northeastern Europe following the collapse of communism, attest to the
naturalness of contractual political strategies in environments with feudal heritage and a common
legal language with the rest of the continent, even if those strategies had not become fully
effectuated endogenously.
IV. Lessons and Contrasts
Western Europe’s constraints on sovereign discretion derive from a legal tradition with roots in the
communitarian values of the Germanic tribes. This enabled a much broader diffusion of
responsibility for lawmaking and enforcement, and the conditional submission strategies that
support them, than in other long-lived rationalist regimes. The obvious question then is, how can
successful conditional strategies be cultivated outside of Europe, in areas without a feudal heritage?
We have sketched the path that the confluence of a rationalist and a communitarian legal
tradition took toward a legal system that credibly restrains a strong central state. But there are many
possible paths such a confluence can take, in principle. It will therefore be necessary to identify
which aspects of the rationalization of Europe’s communitarian tradition have led to agreeable
results. Given what we have argued is a relatively unified European legal tradition in spite of varying
progress in its development across the continent, a sample size of one limits the definiteness with
which we can answer this question. Nevertheless, the persistent failure of the constitutional liberal
project to take root elsewhere in the world allows us to narrow the space of possibilities and to
eliminate some obvious misinterpretations.
Consider several possible outcomes for the attempt to rationalize a communitarian legal
order.
1. The formal law imposed alongside an existing communitarian order may be simply ignored as
“dead letter” – as a Chinese proverb says, “the mountains are high and the emperor is far away”.
Locals may pay lip service to the formal law, but for all intents and purposes their lives remain
governed by the existing communitarian law. There is little disruption, but also little possibility
of exploiting the scale advantages of rationalist law. This is the case in much of Africa and
Central Asia, where a state exits for the purposes of international relations, but de facto political
power is mainly exercised on a tribal level.
13
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2. Alternatively, the rationalizing entity may impose the law at some cost, a cost which rises with
the variance between formal law and existing practice. To the extent that existing practice has
been shaped by the necessity to reduce recurring conflicts, imposed rationalization is likely to
resurface old conflicts (Leeson & Coyne 2012), which the rationalist law may or may not have
sufficient provision for, even if people eventually acclimate to it. The privatization of land
holdings by colonial governments in certain African tribes, for example, cleared away many of
the communitarian defenses against predation and empowered the headman to exercise a great
deal of arbitrary authority that had not been previously possible (Van de Walle 2001).
3. Finally, communitarian law may be rationalized endogenously, either de novo or from the
attraction of an external example. Such was the process in post-Roman Europe, where
Germanic kings slowly adopted pieces of Roman law – first only the legal categories to aid in
the articulation of the existing law, but over time more and more substantiative pieces driven by
the needs of the contemporary society.
In addition to the problem of constructing a stable conditional political strategy, these possibilities
point to the existence of a parallel problem: the legitimacy of any change in political strategy. Any
equilibrium strategy will require, first, the common knowledge that others are deploying it,14 and
second, the incentive compatibility of deploying it given that knowledge.
Any sharp break in political strategy – as for example in (2) – will, by necessity, involve a
break in common knowledge, and for that reason a collapse of the legitimacy of any strategy (cf.
Pejovich 1999: 171). The process of converging back upon an equilibrium strategy may be fitful,
violent, and given local conditions, may or may not result in one that is compatible with the imposed
legal order. On the other hand, slow change – though more amenable to the maintenance of
legitimacy – can prolong contestability, and result in worse equilibrium strategies than even a break
in legitimacy, as ‘gradualists’ have learned in the wake of the collapse of Communism. The
maintenance of a trajectory of change over longer periods of time may itself not be time-consistent
(Roháč 2013).
Third, in the era of nation-states, nearly the entire world is governed, at least in principle, by
rationalist legal systems. The example of Western Europe and its successor states stands as a strong
rationalizing attractor for nearly every culture in the world. Unfortunately, its example shines no
14
In more advanced stages of political and social organization, it will be organized coalitions rather than
individuals employing the relevant political strategy. In such societies, the organized coalition abstracts from
heterogeneity in the level of political motivation among its members and the various separate coordinated
responses made necessary by an attempt at domination.
14
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light on the reverse problem of “communitarianizing” a rationalist legal order, except that perhaps
collapse is necessary – and even so, there must be a viable communitarianism waiting to pick up the
slack. China, for example, extirpated its communitarian traditions very early in its history in
response to the threat from the Mongol steppes. Despite numerous collapses over the course of its
several-millennia history, however, there has never arisen a legal force akin to the feudal tradition to
insulate its citizens from an overbearing central state.15
In a sense, the lessons of the evolution of Europe’s legal order are not especially actionable,
and complicate any efforts to replicate its success elsewhere. Even so, some broad principles are
generally applicable.
First, legitimacy matters. Political strategies are embedded in practice (Harwick 2019), and
generally depend for their stability on a particular persistent pattern of bargaining among interest
groups. Convergence is a hard-won process. It follows that such norms will be resistant to change
imposed from the outside, for better or for worse. Detailed and highly individualized efforts will be
necessary to minimize normative disruption during the process of legal change, and a workable plan
in one part of the world is not likely to be adaptable elsewhere.
One important implication is that it is important to avoid a legal “vacuum” during which
short time-horizon rent-seeking becomes rational and competing legal and political strategies rush
in. In France, for example, seigneurial courts continued to hear cases until well into the era of
monarchical absolutism. By contrast, in many newly independent countries, especially former
colonies, new legal regimes were manufactured and transported from the colonist to replace the
older customs that governed traditional communal relations. Communal custom was eliminated
before a viable alternative had come into play, leaving many aspects of community activity without
legal safeguard. This vacuum enabled the local “big man” to expropriate many of the rights of the
population and use connections with the center to cement those usurpations. The imposition of
national law enabled those with access to it to act without constraints and with limited
responsiveness to local populations, rendering the new institutions of the state into tools of
oppression.
15
Technical feasibility, however, limited the influence that the central state could influence for a long time. In
addition, the Confucian legal tradition consisted in strong norms of self-regulation and good governance
(Zhao 2015). Even so, there existed no independent power base to challenge the emperor’s – or the party’s –
power should Confucian norms fail to hold sway. This is especially true now that technological advances have
removed many of the practical barriers that had formerly protected some individual autonomy (Devereaux &
Peng 2018).
15
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Second, legal changes are more likely to be legitimated when they address existing problems
experienced by the people subject to them. Medieval kings got purchase on the establishment of
Roman law courts because of the unsatisfactory provision of justice by manorial courts. Cities
adopted the Codex Justinianus in whole or in part because of the difficulty of governing commercial
relations under Germanic law. Germanic kings adopted Roman elements in response to the
difficulty of administering vastly expanded territories. Even the initial rationalization of Rome’s legal
system was initiated by the demand of the plebeian class for written rules in response to a sense of
unfair and self-serving rulings, and developed over the course of the next millennium through jurists’
discussion of contemporary legal problems (Stein 1999, ch. 1). Any project of directed legal change,
therefore, will have a greater chance of success the more it can point to specific dissatisfactions with
the existing legal system and offer a credibly superior alternative.
Finally, especially in more advanced stages of political organization, legal strategies affect
political outcomes primarily via their effect on the organized coalitions who employ them. In
Europe, the confluence of Roman and Germanic law resulted in a stable balance of power between
the crown and the nobles that was eventually formalized into recognizably liberal governance
structures. In the U.S., the same political strategy made artifactual political coalitions – namely, a
bicameral legislature and an executive – viable and stable. Such coalitions will not be stable (at least
in the intended form) without a congruent political strategy, as the adoption of US-like
constitutions across the world with little success shows.
V. Conclusion
The legal tradition of Western Europe and its successor states stands alone in the world as a system
that enables a great deal of political and organizational complexity, and at the same time credibly
restrains the exercise of political power enough to support a market economy with significant
concentrations of private wealth. This system has been the backbone of the Western world’s “great
divergence” over the past several centuries, one which has supported the production of historically
unprecedented wealth. That a rationalist theory of rights could be established from out of feudal
loyalties gives the Western legal tradition a unique character not found in other current or past
regimes.
The connection of that system to economic growth has been well-studied, from the very
beginning of the discipline of political economy to the more recent explosion of interest in the
economics of institutions. The origin of particular features of that system has been comparatively
neglected, especially given the problem of striking the right balance between narrowly documenting
16
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the historical development and broadly theorizing about the entire space of possibilities in light of
the single extant example. Approaching the development of the Western legal tradition using the
ideal types of ‘rationalist’ and ‘communitarian’ legal systems brings attention to an important but
often overlooked element of the European legal tradition, and also has broader applicability outside
Europe. We have made some tentative forays into drawing broader lessons; it remains for future
work to apply the distinction elsewhere.
17
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