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The Role and Evolution of Beliefs,Habits, Moral Norms, and Institutions
Stefan Voigt and Daniel Kiwit
It is impossible lo conceive of a prosperous economic order in theabsence of any institutions. Indeed, in the absence of institutions, it isimpossible to conceive of any kind of order in thc sense of "a State ofaffairs in which a multiplicity of elements of various kinds are sorelated to each other that we may learn from our acquaintance withsome spatial or temporal part of the whole to form correct expecta-tions concerning the rest. or at least expectations which have a goodchance of proving correct" (Hayek. 1973, p. 36).
It is thus the role of institutions to bring about order. In this paper,we will argue that not only those institutions which can be set up by
design but also those institutions which emerge and develop, i.e.,evolve, as the spontaneous result of individual action are relevant forthe economic development of a society.
Methodological individualism will be the basis of our analysis of theevolution of institutions. Collectively beneficial results will still have to
be expla incd by drawing on expec ted individual advant age. Everythin geise would be equivalent to committing the functionalist fallacy. Wewill, howcver, not draw on the notion of atomistic, rational individualstrying to maximize narrowly defined self-interest, a notion which hasalready been critized by Hume ( 1985), who therefore wroteabout thc useless fiction of the original contract. Instead, we will focuson individuals already connected to one another via several socialrelationships such as kinship, friendship, etc.
Three areas of inquiry will be distinguished:
(1) The relevance of institutions in influencing individual behavior andthus social outcomes. Institutions are considered as exogenousvariables. In this area of inquiry, we will search for hypotheses thatlink institutions with social outcomes that are of interest to the
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economist, such as per capita income or economic growth. This
area corresponds with the "Role" in the title of our paper.
(2) The explanation of the emergence and development of institutions.
Institutions are considered as endogenous variables. In this area of
inquiry we will search for possible inputs that lead to their emer
gence. This is in accord with the modern conception of economics,
which is defined not by its subject matter but by its method of
analysis. This area corresponds with the "Evolution" in the title ofour paper.
(3) The analysis of possibities to steer societies by deliberat ely
changing or setting up institutions as possible constraints for eco
nomic policy. In this area, we will try to explore the possibities to
influence the evolution of institutions via public policy.
We will proceed as follows: in the next section, we will propose a
taxonomy of institutions and define key concepts. In Section II. we will
deal with the role of institutions in economic development. Section III
is devoted to approaches that try to explain the emergence and devel
opment of institutions and Section IV deals with possible implications
for economic policy. The title of the paper is very ambitious but space
is severely limited. The paper is therefore morc a tour d'horizon thatpresents some possible avenues for future research rather than pre-
senting such research itself.
I A Taxonomy ofInstitutions, Norms, Beliels, and Habits
In this section, we will no t only define th e four central terms thatappear in the title of ourpaper but also try to establish some linksbet wee n th em. As has already become apparent in the introduetion,
most of the emphasis will be put on institutions because it is the mostencompassing ofthe four terms, because it is the term that has reeeivedmost attention by economists, an dbecause it is directly relevant for theemergence an ddevelopment of order. Institutions are rules or norms
that ar e subject to an enforcement mechanism.
To illustrate the funetion of institutions in bringing about order,imagine an anarchic Society. As soon as two individuals begin to inter-
act, Strategie uncertainty is present. If the respective individuals had aset of rules at their disposal, Strategie uncertainty could be reduced by
The Role andEvolution ofBeliefs, Habits, Moral Norms, andInstitutions 85
excluding theoretically possible actions from th e rnge ofactions to beexpected from other actors. Following Ostrom (1986, p. 5), rules
refer to prescriptions commonly known andused by a set ofpartieipants to orderrepetitive, interdependent relationships. Prescriptions refer to which actions (orstates ofthe world) are required, prohihited, orpermitted. Rules are the result ofimplicit orexplicit efforts by a set ofindividuals to achieve order and predietabilitywithin defined situations.
T o be effective, rules have to be supported by an enforcement mechanism. As already stated, rules that ar e supported by an enforcementmechanism are called institutions here. We also classify institutions
with regard to the kind of enforcement mechanism used. A generaldichotomy could differentiate between external institutions which are
ba ck ed by the coereive monopoly of the State an dinternal institutionswhich rely on private enforcement, or enforcement internal to society,thus their name.' Among the five types of institutions, four types of
internal institutions can be distinguished aecording to the enforcementmechanism used (see Table 1).
Let us Start with Conventions. In pure coordination games, all partieipants ar e better off if they coordinate their behavior. There is no
conflictual element, so no partieipant has a preference for any particu-lar Nash equilibrium in case there is more than one.2 Once a particularequilibrium, a Convention, ha s emerged, nobody is able to make him-or herseif better off by deviating from it unilaterally. It is thus self-
enforcing. Some authors (e.g., Sugden, 1986) have extended the con-
1 Ouroverall approach towards institutions is similar to that chosen by North(1990), yet markedly difTerent in irnportant details. North distinguishes betweeninformal constraints andformal rules with an enforcement mechanism. It seemsthat his distinetion focuses on the process ofhow constraints come into being.The criteria forevaluating a constraint as formal or informal are, however,unclear as North (1990, p. 46) adrmls. Aecording to North (1990, p. 47),"(f)ormal rules include political (and judicial) rules, economic rules, and con-
tracts." Aecording to ourdefinition, rules need lo be commonly known. In themajority ofcases, thecontents ofcontracts are, however, not commonly known.It is therefore more appropriate to qualify contract law as a set ofinstitutions,rather than to qualify contracts themsclves as institutions.
2 A Nash equilibrium is a payoff-combination from which no player can makehimself better offgiven that the other player chooses to repeat his move.
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Table 1. Typcs oflns tilutions
Kind ofRuie/Norm Kind ofEnforcement Type ofInstitution
1. Convention Self-enforcing Type 1 internal2. Ethical rule Self-commitment ofthe actor; Type 2 internal
possibly amplified by religiousconviclions
3. Custom Vianon-organized societal control Type 3 internal
4. Private rules Organized private enforcement Type 4 internal5. State law Organized State enforcement External
vention concept to games that do involve a certain amount of conflictan d ar e thus mixed-motive games. Since unilateral defection still does
not make an y player better off, Conventions remain self-enforcing, an dare called type 1 institutions here.
Ethical rules are a second kind of institution to be discusscd now.Prisoners' dilemma (PD) games only have one Nash equilibrium. In
one-shot games, it is always instrumentally rational to defect. If par-ticipants in games that seem to be of the PD type are observed to be
reaching the cooperative solution, they must have becn able to Iransform the PD into a different game. Individuais might have internalized
the strategy to cooperate as "the right thing to do. " In other words: asa result ofinternalization, the payoff for defecting has been substantially
decreased or the payoff forcooperating substantially increased. Partic-ipants thus internalize specific institutions in such a way as to comply
with them intrinsically even ifthey conflict with narrowly defined self-interest. Internally enforced institutions are called type 2 institutions
We no w turn to customs. Whcrcas the first two ways of enforcementare rooted within the strueture of the game or the actor himself, there
are other ways of enforcement which rely on other actors. Enforcement via societal control is one of them. An unspecified variety of
pe rs on s sur vey s co mp li an ce by way ofspontaneous control. This is thethird type of enforcement, on e possible example being to punish non-
compliance by informing others about this behavior in order to dimin-ish the reputation of the person who did not comply. Customs that areenforced via nonorganized societal control are called type 3 institutions here.
We call the fourth type of internal institutions private rules. En -
The Role andEvolution ofBeliefs, Habits, Moral Norms, andInstitutions 87
forcement that makes use ofother actors, i.e., third-party enforcement,
can also be based on some kind of organization. Organized private
enforcement may, for example, rely on private courts of arbitration
that monitor compliance with private rules. Th e enforcement of rules
by pr iv at e or ga ni za ti on s is called type 4 institutions here.
Rules whose noncompliance is punished by the State, i.e., a very
specific organization, are called external institutions because the act of
pu ni sh in g is external to society. Laws an d decrees are examples ofexternal institutions.
Having introduced a definition of institutions and a typology of
different types of them, we now turn to ourunderstanding of values.
They are sometimes differentiated from norms or rules. The Inter
national Encyclopedia of the Social Sciences defines values as
coneeptions of the desirable, influencing selective behavior... . Values are not the
same as norms for conduet. .. Values are Standards of desirability that are more
nearly independent of specific situations. The same value may be a point of refer-
ence for a great many specific norms; a particular norm may represent the simul-
taneous application of several separable values. ("Values," 1968, p. 248)
We now turn to discuss another concept named in the title of our
paper, namely beliefs. Shared values and norms imply shared con
eeptions of the desirable. In order to coordinate one's behavior using
shared coneeptions of the desirable, i.e., of the "ought," the group that
is sharing those coneeptions must have achieved some shared pereep-
tion of the "is " as well. In different int eraction situations, different
norms may apply. Interaction situations do not classify themselves but
have to be classified by the partieipants. Norms will only stabilize
expectations if the people sharing them have a similar way of classify-
ing the interaction situat ions they are confronted with. If two people
belicve to be confronted with different interaction situations, their
expectat ions might be disappoin ted although both faithfully try to
stick to the norms applicable to the respective Situation they believe
to be confronted with. We will therefore assume that shared norms
imply not only shared normative coneeptions but also shared cognitivepereeptions. Conjectures, or ideosyncratic hypotheses, abou t how the
world is and how it funetions can also be called beliefs.
Habits are factual regularities in behavior. As emanations of in-
dividual rules of thumb, they reduce Information or decision costs.
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Simon (1955) introduced the notion of bounded rationality into eco-nomics, which simply recognizes the fact that obtaining and process-ing Information is costly. It can therefore be rational to use rules ofthumb (Heiner, 1983). These are, however, individual rules that are notsocially enforced. They do not, as such, entail any normative expeeta-tion that somebody should act in a speeifie way in a given Situation.They can, however, contain the seeds of socially relevant institutions.
This will be discussed below.
II The Role of Institutions in Economic Development
Throughout this section, we will assume that therc is uncertamty inhuman actions and that transaction costs are thus positive. Coase(1937) introduced the coneept of transaction costs to draw attention tothe fact that market exchange is costly. But he also drew attention tothe fact that organizations do not funetion costlessly either. We willuse the term "coordination costs" to include the costs of using marketsas well as the costs of using organizations (see also Streit and Wegner,1992). The coordination costs members of a society face in their inter-
actions determine, inter alia, the amount of interactions that will takeplace. If they are too high, exchange that could make all parti eipan tsbetter off, will no t take place. If the institutions prevalent in a societyhave a substantial influence on the amount of coordination costs, theirpotentia l relevance to the allocation and distribution and thus to economic development becomes apparent. It is conceivable that institutions lead to lower as well as to higher coordination costs. To evaluatethe relevance of institutions for the economic development of a society,one thus needs to speeify the material content of the institutions sharedby most members of the society in question.
Three classes of interactions in which coordination costs can be in-fluenced by institutions will be distinguished: (1) horizontal exchange, orinteractions on markets; (2) voluntarily entered into vertical exchange,
or interactions within firms; and (3) vertical exchange backed by force,or interactions between Citizens and State.
(1) Markets are based on the "exchange paradigm." If two personsvoluntarily agree to exchange goods, both expect to be better off as a
The Role and Evolution of Beliefs, Habits, Moral Norms, and Institutions 89
result. Otherwise, they would not enter into an exchange in the firstplace. Norm s that prevent the emergence of a market altogether bysubstantially increasing coordination costs lead to a division of laborthat is lower than it could be if a market could emerge. It can thereforebe expected to reduce the potentia l for material welfare. This is thecase when some goods are exempt from the rnge of tradable goodsaltogether, as, for instance, drugs, pork, parts of the human body, etc.
But suppose a market can emerge. Institutions might then constrainthe extent of the market: They might reduce the number of potentialtrading partners (by forbidding trade with anyone of a different race,religion, nationality, etc.) or alter the terms of trade (when creditfinancing or bargaining is socially not acceptable). Some terms of trademight be pereeived as unfair and might therefore not be aeeepted.Scholars of descriptive decision theory have presented vast evidencethat economic actors are ready to ineur some costs if they feel thatothers are offending their coneept of fairness (for empirical evidence,see, e.g., Kahnemann, Knetsch, and Thaler ). An example canfrequently bc observed at gas stations when the major brands aretrying to increase the price of fuel: long queues will build up quickly atunaffiliated stations, with consumers waiting a long time just to save acouple of cents. This description of the possible relevance of institu
tions might mediate the impression that by their constraining either theexistence of a market altogether or by constraining at least its extent,they would generally bc a hindrance to economic development. Thisconclusion is, however, obviously wrong. Institutions can also substantially lower coordination costs in markets, e.g., if they promotehonesty or punctuality.
Widely shared cooperation norms will lead to mutual trust amongmembers of a society even if the interacting persons do not know eachother. If, a priori, potential trading partners are expected to cooperaterather than to behave opportunistically given the smallest Chance, thiswill increase the amoun t of potentiall y welfare-increasing transactions.The importance of trust in facilitating exchange relationships has beendescribed with regard to Italy. This is especially interesting because its
external institutions are identical all over the country, whereas peoplein the south often share different norms than people in the north,i.e., its internal institutions vary in different regions. Banfield (1958)describes the dominant norm prevalent in the village of Montegrano insouthern Italy as: "Maximize the material, short-run advantage of the
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nuclear family; assumc that all others will do likewise" (p. 85).3 Thedifferences in economic development between northern and southernItaly are, inter alia, due to these differences in internal institutions.
(2) In interaction situations within firms, institutions can also influencecoordination costs. An often quoted institution is the solidarity among_employees who rcfusc to train junior colleagues who do the same work
but receive lower wages (Akerlof, 1980). The resulting wage rigiditynot only influences the wage structure within firms but also the unem-ployment rate. Anothe r example of the relevance of insti tutions withinfirms is the informal control among employees who monitor their ownwork effort, which can have various effects: if institutions exist that
punish overachievcrs, the productivity of a Company will remain belowits potential. On the other hand, institutions that promote teamworkcan lead to substantial savings in formal monitoring costs as one kindof coordination costs.
(3) In interactions between Citizens and the State, the relationshipbetween internal and cxtcrnal institutions becomes relevant. Recallthat internal institutions are enforced within socicty, whereas externalones are enforced by the State. Drawing on simple logic, four possiblerelationships between internal and external institutions can be con-ceived of:
(1) A neutral relationship, i.e., the institutions regulate different areasof human interaction.
(2) A complementary relationship, i.e., the institutions constrain humanbehavior in an identical or similar fashion and rule-breaking be-havior is punished by private individuals as well as representativesof the State.
(3) A substitutive relationship, i.e., the institutions constrain humanbehavio r in a similar fashion but rule-breaking behavior is pun-ished either by private individuals or by representatives of theState.
(4) A conflicting relationship, i.e., the institutions constrain human
3 See also Putnam (1993); Voigt (1993) attempts to compare the value Systems ofthe Central and Eastern European societies and draw conclusions concerningtheir potential for economic growth.
The Role and Evolution of Reliefs, Habits, Moral Norms, and Institutions 91
behavior in different ways. Abiding by an internal institutionwould then be equivalent to breaking an external one and viceversa.
If the relationship between internal and external institutions is a conflicting one, this will increase coordination costs. If it is complementary, it will decrease them because the State has to provide fewer
resources for the enforcement of its institutions. Trust may also playan important role in the relationship between Citizens and their State.In modern social philosophy, the State is often conceptualized as beingcreated by the Citizens by way of a contract. This would mean that theCitizens are the prineipal, and the State is their agent. In many realworld situations one has, however, exactly the opposite impression: theState teils the Citizens to pay taxes, and the Citizens often appear to beagents of the State. Now, if the State "trusts" its Citizens to pay theirtaxes and does not control their taxpaying behavior closely, this mighthave two effects: (1) the Citizens might be more willing to pay theirtaxes because they feel they are being treated as responsible Citizens(Frey, 1997; see Deci and Ryan  for a more general treatment ofintrinsic motivation) and (2) the State budget for tax administrationcan be smaller, which can lead to lower tax rates.
To sum up: Institutions can indeed be relevant to economic development. Whether they enhance or reduce a society's prospects foreconomic development depends on their material content and on thedegree of their enforcement.
As a next step, we will therefore present a list of rules that are sup-posedly favorable to economic development if they are enforced to aconsiderable extent. The list names some of the rules that seem to beeither necessary for, or favorable to, growth in an economic Systembased on individual liberty. The fundamental hypothesis underlyingour "list of rules condueive to economic development" is that economic Systems that are based on individual liberty have proven to
provide individuals with the greatest opportunity to enhance theirwealth (recent studies that find a positive correlation between eco
nomic freedom and growth rates are Bhalla  and Gwartney,Lawson, and Block ). Giersch (1995, p. 7f.) divides the moralitythat led to the rise of Western civilization into (1) a morality of prop-erty, (2) a morality of contract, (3) a morality of individualism, and (4)a republican morality.
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(1) The morality of property can be translated into the rule "Respectthe property of others." The significance of this rule for the eco-nomic development of a society is almost self-explanatory. As theproperty rights theory shows, we can only expect individuals toeconomize on resources if they can internalize the fruits of theirefforts while also having to bear the possibly negative consequencesof these efforts.
(2) The morality of contract can be translated into the rule "Puctasunt servanda" The economic relevance of this rule is also ob-vious. If it is absent, the amount of profitable exchange and theproduetivity-enhancing division of labor will remain low.
(3) The morality of individualism can be translated into the rule"Become active in order to reach your own goals." It is the indi-vidual actor who is responsible for decision-making, for carryingout the decisions and for reachingor not rcachinghis or hergoals. If success in life is, however, pereeived of as being largelyout of the individuafs control and as being determined by God,destiny, or some organic entity, we would not expect a marketeconomy that is based on private aulonomy and that depends onentrepreneurial spirit to develop.
(4) The morality of republicanism is hard to translate into one speeifierule. This morality requires that individuals be able to assume theStandpoint of an impartial speetator (Smith  1984, p. 112)and to act aecordingly. This means that they must have some pro-pensity to contribule voluntaril y to the produetion of collectivegoods, e.g., to vote. Voluntary contributions are especially relevantif individual behavior cannot be observed and therefore cannot bepunished by othe rs.
III Explaining the Emergence of Norms
If moral rules are defined as rulcs which aim at strueturing interactionsituations involving some conflict, self-enforcing Conventions, as results
of pure coordination games, do not fall within the rnge of institu-tions whose emergence needs to be explained. We will therefore restrictourselves to discussing some approaches that have been advanced toexplain type 2 and type 3 institutions, i.e., institutions that are eitherenforced via mternalization or via nonorganized social control.
The Role and Evolution of Beliefs, Habits, Moral Norms, and Institutions 93
A Drawing on Other (Social) Sciences?
Ullmann-Margalit (1977, p. 8) has called attempts to explain theemergence of speeifie norms as futile as attempts to explain the originsof languages or of a joke. Rather than attempting to explain theemergence of speeifie norms, we are interested in general mechanismsthat lead to their emergence, diffusion, and development. Above, we
equated behavior in aecordance with norms with behavior deviatingfrom narrow instrumental rationality or Homo economicus as oftenmodeled in economics. If, however, conformity with norms is observeddaily on a large scale and is furthermore relevant to the economicdevelopment of entire societies, the question of whether the explana-tory power of the economic approach can be enhanced by drawing onother diseiplines almost suggests itself. Because of space restrictionshere, our treatment of this question in the following might be some-what distorted and thus might not do justice to these diseiplines.
Traditional sociology, which is based on the model of Homo socio-logicus, who is attributed various roles by society and is assumed toeonform to the normative expeetations that come with his or her various roles, is not a good starting point for our purposes because func-tional sociology takes norms as exogenously given and is thus of littlehelp.
Over the last decades, a competing approach to sociology which isbased on the rat ional choiee paradigm has emerged. In his Foundationsof Social Theory, James S. Coleman (1990) tries to show that the pres-ence of externalities is a necessary condition for a demand for effectivenorms to arise. A second condition (see below) could secure that thedemand will be satisfied. In an earlier paper, Coleman (1987, p. 140)had poignantly described his view: "The central premise ... is thatnorms arise when actions have external effects, including the extremecases of public goods or public bads. Further, norms arise in thosecases in which markets cannot easily be established, or transactioncosts are high." In other words, norms strueture social interaction.Externalities being absent, there is hardly any need for social norms.
On the other hand, externalities are either omnipresent or they canbe created such that they are omnipresent . If they are omnipresent ,norms can arise that regulate pretty much any interaction Situation.This does not, however, mean that one could deduce a similarly omnipresent demand for social norms because externalities are not objec-
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tively given but subjectively created by the affected individuals. Onetherefore has to determine which externalities society has created as aconsequence of a plurality of persons having perceived a particularphenomenon similarly. To give an example: A noisy motorcyclistriding the narrow streets of Naples, Italy, at ten o'clock at night willsupposedly be evaluated as producing fewer negative externalities thanthe same motorcyclist at the same time in any German town. Thismeans that explaining the emergence of norms by drawing on externalities is impossible without taking the perception of the underlyjng^interactions by possibly affected parties, and thus their cognition,explicitly into account.4
The second condition Coleman mentions is that there must be anindividual readiness to punish norm-deviating behavior. In order tostructure social interactions, a norm needs to be accompanied bysome means of punishing individuals when they deviate from t henorm. Punishing norm-deviating behavior is, however, costly and anyrational choice approach will have to explain why some people arewilling to engage in this costly business. Coleman describes this as "thesecond-order public good problem" of norms. The second conditionreads (Coleman 1990, p. 273):
Stated simply, this condition is that undcr which the sccond-ordcr free-rider problem will be overcome by rational holders ofa norm. To put it differently, the condition is that under which beneliciaries ofa norm, acting rationally, either will beable to share appropriately the costs of sanetioning the target actors or will be able
4 Littlechild and Wiseman (1986, p. 166) have a nice example of how diversely
externalities can be perceived and construeted:
Consider some of the various ways in which Smoking by one person A might be arguedadversely to aflect a nonsmoker B:
a) B's health may be adversely affected, in ways that can be veriiied by persuasive empiri-cal evidence.
b) Even withou t such evidence, B may believe that bis health is adversely affected.c) B may be simply annoyed by tabaeco smoke.
d) B may be concerned about the effect of Smoking on A's health.e) B may be concerned abou t the etfect of A's Smoking on the happiness ofthi rd party C,
who is exposed to A's smoke, or on third party D, who is a concerned friend or relativeof A.
f) B may be annoyed a t whal he believes is A's lack of awareness of the suffering he iscausing.
The Role and Evolution of Beliefs, Habits, Moral Norms, and Institutions 95
to generate second or der sanetions amo ng the set of beneficiaries that are sufficient
to induce effective sanetions of the target actors by one or more of the beneficiaries.
This, however, is not an explana tion but a logically consistent refor-mulation of the problem.
Evolutionary approaches, just as traditional sociology, do awaywith explicit individual rational choice. They are not interested in the
choiees of individuals, but rather in the chances that competingbehavior al strategies have of surviving in a competitive environment.Rationality is then defined as maximizing one's chances of surviving,and those who do survive must have acted as if they were rational(Alchian, 1950; Friedman, 1953). Arguments explicitly based ongenetic evolution are relatively seldom because they only apply to thevery long run. With regard to explaining the emergence of norms, theyseem to be utterly misleading because they are incapable of explainingthe vast differences in behavior of different individuals as well as thevast differences of norms between different societies (see also Kirch-gssner  who uses the argument against sociobiology).
Often, evolutionary approaches are not based on genes but on"meines" (Dawkins, 1989). These are cultural traits which are sustained
and transmitted by memory and mimicry. Colman (1982, p. 267)describes the notion as follows: "A meme will spread through a pop-ulation rapidly if there is something about it that makes it better ablethan the available alternatives to infect people's minds, just as germsspread when they are able to infect peoples bodies. This analogy drawsattention to the fact that the rittest memes are not necessarily ones thatare beneficial to society as a whole." In their anthropological viewtowards the evolution of norms, Boyd and Richerson (1994) use theconeept of memes, whose diffusion they model analogously to the dif-fusion of innovations. Norms are defined as those memes which influ-ence Standards of behavior.
One merit of their approach is that it takes the approaches ofanthropology and traditional sociology explicitly into account. It alsoStresses the importance of beliefs, rules, and values, i.e., the cognitiveside, for explaining the emergence of norms, which is also an advan-tage. They try to manage the splits between anthropology and eco-nomics by drawing on three forces of cultural evolution, namely biasedtransmission, which is based on explicit choiees by the actors, unbiasedtransmission, which takes place during a person's childhood, and nat-
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ural selection, which functions just as genetic Variation. Biased trans-riiission is described in analogy to the diffusion of innovations. Jus t asa person has the choice of adopting an innovation, a person also hasthe choice of adopting those memes for which he/she has preferences.Notice that this is not compatib le with the diffusion mechanism ofmemes described above. In our view, the assumption that norms aresubject to deliberate choice is mistaken. Norms structure our inter-
actions even if we explicitly refuse to accept them individually or if wedo not perceive the necessity of choosing at all. The analogy is mistaken because the adoption of an innovation is subject to deliberatechoice, which norms are not. Because of the behavioral strategies per-spective prevalent in evolutionary approaches, the social interactions
by which norms get diffused remain unspecified. These inter actions,however, should be the very essence of an explanation of the diffusionof norms if norms are decmed to structure social interaction.
Furthermore, evolutionary approaches remain unsatisfactory because the existence of a set of memes out of which the participantsindividually choose those that suit them best has to be assumed. Theemergence of memes is thus not dealt with within evolutionaryapproaches.
Evolutionary game thcory is the analytical tool used by many rep-resentatives of an evolutionary approach. Compared with Standardgame theory, it has the advantagc of not making such demandingassumptions concerning the computational capacity of the players. Abird or a rat that structures its behavior using trial and error will dofor the purposes of this approach. This, however, can also be seen asa disadvantage: it remains unclear what role the human capacity toreason, to conjecture, or to hypothesize plays in such modeis. Majeski(1990, p. 277f.) notes that most empirica! work on the evolution ofstrategies rests on a biological birthdeath mechanism: "This is not sur-
prising since it is the only appr oach that can be formalized and testedwithout developing a model of individual cognition. It is, however, theleast persuasive approach for explaining the effects of norms on social
behavior A rejection of a biological perspective leaves onlyapproaches that have some form of human cognition."
Having perused some of the approaches that try to explain theemergence of norms and having evaluated them as uniformly uns atisfactory, it might seem promising to turn back to a somehow modifiedrational choice approach.
The Role and Evolution of Beliefs, Habits, Moral Norms, and Institutions 97
B Trying to Broaden the Tradit ional Notion ofHomo Economicus
Instrumental rationality has traditionally been intcrprctcd very nar-rowly. If the time horizons of the actors are assumed to comprise onlyone round, Solutions to repeated games cannot be incorporated. Assoon as the actors are able to structure interaction situations asrepeated games, the rnge of possible Solutions rises considerably. It
may even rise when the actors that play two-person games repeatedlyare not always the same actors, as long as they can communicateInformation cheaply and reliably on how a specific actor has behavedin previous rounds. It has been shown that conditional cooperation isone among many strategies that can be sustained in an indefinitelyrepeated PD (the so-called folk theorem, Fudenberg and Maskin). It might even be possible to sustain a cooperative solution infinite PDs for a number of rounds. If actors can transmit informationamong themselves cheaply and reliably, uncooperative behavior candestroy a participant's reputation and thus diminish the value of his orher future payoffs.
For this to be the case, however, three necessary conditions have tobe fulfilled: (I) the uncooperative behavior must have a certain amoun t
of publicness, i.e., it must be known by not directly involved thirdparties; (2) these parties must all be aware of the same facts concerningthis behavior, i.e., they must all know about the same interaction Situation; and (3) they must evaluate the relevant facts concerning thisbehavior in this Situation similarly, i.e., they must share the normsunderlying the evaluation of this behavior. This means that the cogni-tive side of behavior, i.e., the shared beliefs, comes into play again. Italso means that reputation is based on something like proto-norms.Since the ability of reputation to induce people to cooperate dependson the existence of (proto-)norms, reputation itself cannot be used toexplain the emergence of norms but only to explain norm-abiding behavior.
Pointing towards reputation and repeated games rationalizes ap-parently nonselfish behavior as more subtle selfish behavior. This still
leaves cooperative behavior in nonrepeated games between anony-mous participants who stand very low chances of ever meeting againunexplained. To explain such cooperative behavior, broadening thenotion ofHomo economicus would then not refer to the presumed timehorizon of the actors but to their assumed rationality. The Standard
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model for evaluating such behavior is based on instrumental rational-ity, on actors who are supposed to be able to compute very complexoperations in an error-free manner. A broadened notion of Homo eco-nomicus could incorporate trial and error processes....
There have been numerous attempts to explain the emergence ofnorms without taking recourse to Standard game theory. Axelrod(1986), e.g., explicitly departs front using this analytical tool: "empir-
ical examples of changing norms suggest that real people are morelikely to use trial and error behavior than detailed calculations basedon accurate beliefs about the future" (p. 1097). In his Evolutionary
Approach to Norms, Axelrod asks how one can explain the viability ofnorms given that punishing norm-deviating behavior is costly. Henames eight mechanisms which can serve to support norms, amongwhich metanorms, internalization, social proof, and reputation arenamed. His approach thus hinges on the people's readiness to punishnorm-deviating behavior. How this readiness emerges must then beshown if one is interested in explaining the emergence of norms.Unfortunately, these mela-norms are introduced exogenously.
Sugden (1989, p. 89) also explicitly rejects Standard game theory:"The ideally rational but complctely inexperienced players of elassicalgame theory would find that they had insufftcicnt data to determinewhat they should do. In contrast, ordinary people with limited ratio-nality but some degree of experience and imagination might have nodifficulty in coordinating their behavior." It is thus experience andempalhy that enable people to coordinate their behavior. SugdefTcon-tinues by drawing on Schelling's (i960) concept of prominence or focal
point Solutions. Conventions and norms that are susceptible to analogyi.e., that can be transferred from one known solution of a coordina-tion Situation to a similar, yet new coordinalion Situationcouldspread best. Here, the danger of getting caught up in "infinite regress"looms large: if one goes back to explaining a norm using an analogousnorm, one will end up with one "last" norm which is not susceptible toanalogy.
C An Emerging Synthesis?
So far, we have tried to explain the emergence of norms by drawing onother concepts used in the social sciences and by trying to broaden thenotion of Homo economicus. None of these attempts has been fully
The Role and Evolution of Beliefs, Habits, Moral Norms, and Institutions 99
satisfactory. We think, however, that the broadened notion of Homoeconomicus is most promising. The main problem with that notion hasto do with one of three necessary conditions of the reputation mecha-nism to work, namely the existence of shared (proto-)norms. A satisfactory approach should allow for an explanation of the emergenceof such norms. In this section, we will try to give one possiblc explanation for the emergence of these norms. This will be done using the
methodological tool of conjectural history.Drawing on the notion of broadened Homo economicus, it can beshown that factual regularities in cooperative behavior can emerge.This holds for pure coordination games without any conflictual ele-ment as well as for mixed motive games mvolving a considerableamount of conflict. Factual regularities in cooperative behavior do nothave to imply the existence of any normative claim that people shouldbehave in the way they actually do. We arguc that factual regularitiesin cooperative behavior can acquire normative Status. Suppose thatsome person has demonstrated clear-cut regularities in his or herbehavior towards others, who have as a consequence formed expec-tations concerning his or her behavior. If their expeetations are frus-trated, this will lead to resentment among them and anger towards theperson who has frustrated them. Regularities in individual behavior
can, then, lead to expeetations of others that the individual will act inthe same way in the future. Because individuals have to rely on regularities in the behavior of others in order to coordinate their actionssuccessfully, the expeetation that individuals will behave in the futureas they did in the past can become a normative expeetation in thecourse of time. If we assume that humans strive for the approval ofothers, this can constitute an additional incentive to conform with arule that has acquired normative Status. This story is, of course, notnew. It was David Hume ( 1990) who first used it. In his aecountof the emergence of norms, Sugden (1986; 1989) draws heavily on it:"Our desire to keep the good will of others... is more than a means tosome other end. It seems to be a basic human desire. That we havesuch a desire is presumably the produet of biological evolution" (1986,
p. 152). This amounts to a reintroduetion of biological evolution.Using conjectural history and some group selection mechanism, onecan conjeeture that biological evolution has negatively selected thosepersons who were not endowed with genes that caused them to strivefor the approval of others.
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Striving for the approval of others means that their approval enters
as one argument into our Utility functions and thus does away with theconcept of atomized individuals. Ever since Hobbes, social scientists
and philosophers alike have tried to solve the problem he first for-mulated, namely how to explain the emergence of order from an insti-tution-free State of anarchy drawing solely on atomized individuals
whodue to the absence of institutionsare incapable of credibly com-mitting themselves to certain actions which would make the respective
interaction partner worse off. Kliemt (1991, p. 194f.) argues that theHobbesian problem has only apparently been solved because the
capacity to commit oneself has often been smuggled in (Kliemt [1991,p. 194f.] names Schotter  as an example in which this capacity is
smuggled in; Gauthier  would be another one). Frank's (1988)"commitment model" can be read as an approach to solvc the com-
mitment problem by taking recourse to emotions. He argues thatemotions like anger or guilt can serve as signals as to what type of
pcr so n on e is. If the y ar e cos tly to fake , the y can be co mc a val ua bl eclue in predicting other people's behavior. The commitment problem
would thus be mitigated by hard-wired commitment mechanisms.Frank reports that in 14 out of 16 studies, the reliability of predicting
cooperation based on such clues was significantly better than chance.
The benefit of being a cooperator would lie in being able to recognizeother potential cooperators and to interact selectively with them.
Above, we showed that cooperation can emerge in repeated games
even if they entail a relatively high amount of conflict. It can, however,be ob se rve d th at so me gr ou ps ar e mo re success ful th an ot he rs in
bri ngi ng ab ou t reg ula ri tie s in co op er at iv e beh avi or . We ar gu e her ethat after having cooperated in a game with little or no inherent con
flict, people will have learned, step by step, to cooperate in gamesinvolving ever more conflict. The rationale of this hypothesis is very
simple: the greater the inherent conflict in a game, the greater the riskof being exploited by the Opponent. But if the members of a society
were able to successfully cooperate in a game involving a certainamount of conflict, x, the probability that they will try to cooperate in
another game involving a greater amount of conflict, A-4- e, should behigher than in the case in which the members of the society reached alow level of cooperation (for a measure of amount of conflict involved
in games, see Axelrod ).
This hypothesis suggests that the emergence of moral norms might
The Role and Evolution of Beliefs, Habits, Moral Norms, and Institutions 101
very well be a path-dependent phenomenon in the sense that it is a self-reinforcing process. It can also remind us not to neglect the cognitive
side of behavior, which can be crucial to solving interaction problems:an apparently identical interaction Situation might be constructed by
members of society A to contain a certain amount of conflict, x,whereas the members of a society B might reconstruct it as containing
twicc the amount of conflict. namely 2x. Different societies can thus
differ in their ability to successfully coordinate their behavior.Ullman-Margalit's(1978, pp. 121-127) approach to the emergence ofnorms seems to be very similar to the one advanced here: she discusses the
game of stag hunt as an intermediary case between a pure coordinationgame and the PD and argues that the PD can be turned into a game of
stag hunt "given, first, a general belief that people's choices will displaysomc habitual stability and, second, a favourable starting-point where
cooperation has somehow been initially established" (p. 124). 5
5 The stag hunt game is described by the following payoff matrix:
Cl (stag) C2 (rabbit)
Rl (stag) 3 3 0 2R2 (rabbit) 2 0 2 2
In order to catch a stag which promises higher Utility than a rabbit to bolhplayers in this game, the row chooser and the column chooser have to coordinate their behavior. After having promised each other to cooperate and afterhaving separaled, it is not entirely clear whether they will stick to their promiseas soon as they see a rabbit which each can catch on his ownand thereforewith certainty. Both might end up catching rabbits and might therefore be worseoff than they could be if they Fiad been able to coordinate their actions.
Binmore (1994, pp. 120-125) contains a discussion of the stag hunt game.Our argument is that the probability that two opponents will cooperate in aprisoners' dilemma is substantially higher if they belong to a society in which theRl -C l solution to the stag hunt game is a firmly established norm. We have
thus left the firm grounds of game theory because our prediction of how twoaetors will behave depends on how they have behaved in other games and isthus not contained in the matrix of the current game played.
We think we might be dealing with an emerging synthesis because manyauthors have told similar stories concerning the emergence of norms largely in-dcpendently of one another. Here is Majeski's (1990, p. 276) story:
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Walliser (1989) ironically describes the game-theoretic State of the
art as being capable of explaining the solution to minor coordinationProblems such as Iraffic lights but not being able to explain more
complex ones. As we have seen, being able to explain how people solveminor coordination problems might provide a clue for the explanation
of more complex ones. In a somehow related vein, Binmore (1994,p. 186) argues that normative (i.e., cooperative) behavior will not sur-
vive in situations "that are genuinely crucial to what holds societiestogether." Binmore seems to say that as the stakes are increased,
peo pl e will eve nt ual ly swi tch to un co op er at iv e (n on mo ral ) be ha vi or .
This is, of course, one of the most basic assumptions of Utility theoryand we think it is a realistic description of most human behavior (not
of all though, because we do not want to exclude the possibility oflexicographic preferences, i.e., preferences where no amount of good can mak e up for a missing good oc, by assumpt ion). We thi nk, however ,that the consequences Binmore infers from this assumption do not nec-
essarily follow: Society does not need heroes and saints with lexicographic preferences to cohere. Instead, if many people are willing to
incur low costs in order to produce public goods voluntarily, societycan cohere and prosper. An example is participation in elections (for
a theory of low-cost decisions, sce Kliemt  and Kirch gssn er
).Our story of how Conventions and norms might evolve does not
hinge upon the instrumental rationality often used in Standard gametheory. Indeed, people who possess that sort of instrumental ration
ality would supposedly be unable to bring about social norms. Whatconsequences does this insight have for the way we try to model be
havior? If our actors possess a capacity to learn, it makes sense to model
The first time a rule that eventually becomes a norm is invoked by an individual in thegroup it is nota norm. It is an individual contextually generated decision rule.... An individual rule becomes a norm when the application of the rule by other members of thesocial group isjustified by appeal to the precedent application, or when the application is
justified by the individual as the expected and/or appropriate behavior ofa member of thegroup. Also, an individual rule becomes a norm when the rule is so established in the
group that individuals pereeive it to be the only plausible alternative.
Other auth ors from diflerent fields and with differenl backgrounds include MaxWeber ( 1985, p. 191f.), Friedrich A. Hayek (1973, p. 96), William Graham Sumner ( 1992, p. 358), and D. Lewis (1969, p. 99). This line ofthought can be traced back to Aristotle and his Nicomachaen Etlrics.
The Role and Evolution of Beliefs, Habits, Moral Norms, and Institution^ 103
them not only as forward-looking but also as backward-looking. Theytake into aecount the experiences they have made in previous rounds.
Mueller (1986, p. 9) writes: "More generally, an effort to model humanbeh av io r bas ed on real ist ic as su mp ti on s ab ou t 'h ow men th in k' ; as
opposed to 'how they would think if they were rational' would placemore emphasis on the experience of the individual in relationship to
the context in which the decision is posed, and less on the consequences
of the decision." Mueller thus pleads for a model of "adaptive egoism"(instead of rational egoism) which takes path-dependence explicitlyinto aecount.6
He proposes that economics be oriented towards behavioral psy-chology. He argues that actors who have been educated to cooperate
in many situations, can be predicted to cooperate even if they do not getthe immediate reward anymore that they got when they were children.If this is taken in to aecount , it almost suggests itself to model hum an
be ha vi or usi ng a tw o-s tep pr oc ed ur e: Th e first Step con sis ts of a dec ision rule that teils the actor how to classify a problem: if a cooperation
norm is involved and the monetary stakes are rather low, the actor willsupposedly stick to the behavior he or she has been taught, i.e., instru
mental rationality in the economic sense of a cost-benefit calculus willnot come into play. As the monetary stakes are gradually increased,
more and more actors will at least begin to classify the problem in whichcosts and benefits have to be weighted in a ration al, future-orient ed
manner. Supposedly, only a small number of decision problems aretotally immune from ever becoming subjeet to an explicit cost-benefit
calculus. As long as this switch in the treatment of a speeifie decisionpr ob le m do es no t exh ibi t any reg ul ari tie s, thi s mo de l is of lit tle hel p to
the scientist. The task of research would thus consist of developinghypot heses concern ing the "swit ch" (see also Kliemt, 1991, p. 199).
6 However, we are not prepared to follow him in his conclusion that over timethose institutions will survive and prosper that "maximize group survivalchances" (1986, p. 18f.). Precisely because path-dependence is potentially relevant, this cannot be assumed. Various authors (e.g., Ullmann-Margalit, 1977;
Sugden, 1986) have observed that a normor more generally, an Institutionneed not be elTicient simply because it has survived. The stability of norms canhave the consequence that they are still abided by although they have long losttheir functionality. Norms can thus prevent (welfare-increasing) change. Kiwitand Voigt (1995) and Kiwit (1996) discuss possible path-dependences in thedevelopment of institutions.
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Lindenberg (1992) is a first step in that direction. He Claims that threeinstrumental goals exist universally: gain, norm-contbrmity, and . lossavoidance. Depending on the framing of a Situation, one of them willbe mor e import ant to the ac tor than the other two (which is not to saythat the other two become completely unimportant). If one is able toinfluence the way people strueture various interaction situations, onecan influence the way they behave.
IV Policy Implications
Some time ago, one of us was discussing the relevance of values andnorms to the development of Russia with a Russian advisor to a lead-ing Russian politician. He stated that they had understood the relevance of values and norms and that they were about to introduceWeber's Protestant Ethics to Russia. He did not mean that Weber'sbook would be transl ated into Russian but that some central agencywould teil the people to behave aecording to the ethics of Protestantsects. This story reminds us of the fact that values and norms usuallyemerge and develop over very long periods of time without anybodyhaving preconeeived them. They are thus the result of human action
but not of human design (Ferguson ,  1988). It can also remind usthat no central agency will be able to control their development. Thedegree to which policies concerning values and norms can do any goodmight therefore be severely limited.
In modern societies with many members and a high degree in thedivision of labor, relying primarily on internal institutions is not onlyimpossible but also undesirable because rights would be unsecure.External institutions are thus needed. We have seen above that coor-dination costs increase if internal and external institutions conflict witheach other. Since internal institutions are not subjeet to deliberatechange, whereas external institutions are, one policy implication is thusthat the external institutions of a society should be shaped in such away that they do not flatly contradict its internal institutions. If a large
majority f society strongly shares the value of (outcome) equalityand its external institutions do not contain any (re-)distributive ele-ment, the external institutions will have a hard time gaining legitimaeyamong the population. Trying to establish external institutions com-
patible with the concept of a market economy but incompatib le with
The Role and Evolution of Beliefs, Habits, Moral Norms, and Institutions 105
the internal institutions of a society might then lead to outcomes worsethan those that might result if the content of the internal institutionswere explicitly taken into aecounf when modifying the external institutions. This can be the case if the external institutions do not gain anylegitimaey, the order appears unstable, investment is therefore low, etc.
The necessity to rely on external institutions is not questioned byFrey (1997). But he claims that external institutions which assumeeverybody is a "knave" and that aim at minimizing opportunistic be-havior can lead to a crowding-out of civic virtue. A constitution that isbuilt on Citizens' trust in their politicians and politic ians' trust in theirCitizens could, in turn, lead to a crowding-in of civic virtues. Repub-lican rules could be maintained by allowing populr initiatives andreferenda.
Values and norms have traditionally been thought to be an inde-penden t variable, whereas the potentia l for economic development hasbeen though t to be the dependent variabl e. Up to a certain degree, itmight also be possible to conceptualize values and norms as the dependent variable. One could, e.g., try to establish an education Systemin which rules favorable to economic growth are promoted. If a per-son's value System develops primarily during his or her childhood andremains rather stable for the rest of his or her life, this is only straight-
forward. But there are severe limits: a theoretical education alone willsupposedly not suffice because people learn by imitation, i.e., theinstruetors would have to live the values and norms they teach in orderfor them to spread.
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Part IIThe Frontiers of Markets