Western-style neoclassical economics was designed for settings where national institutions are already in place. In most of the world, they are not. The question is not “market vs. government,” but how to strengthen the norms and institutions that will build both markets and governments at the same time and in the right directions.

Tyler Cowen tossed this off rather casually in a blog post about Latin America. I am supposed to give a talk on political economy in a couple months, and what Tyler wrote pretty much sums up what I plan to say.Standard political economy uses what I call the “three-corner” model, with individuals, markets, and government as the main agents. Sweetwater economists see individuals as rational, markets as self-adjusting, and government as made up of self-interested individuals. Saltwater economists see individuals as impaired, markets as prone to fail, and government as a benevolent social optimizer.

What the three-corner model misses is exactly what Tyler talks about–the norms and institutions in which individuals, markets and government are embedded. Two comments to make about those:

1. Mutually beneficial trade among strangers depends on a fairly high level of moral and mental development. (Some people think that this point is made well in a book by Paul Seabright called The Company of Strangers. I was actually somewhat disappointed by the book, but perhaps it was because I was already a believer in the main thesis. So what seemed right about his ideas did not surprise me and what surprised me about his ideas did not seem right.)

2. One can observe a very large difference between what I call single-affiliation societies vs. multiple-affiliation societies. In a single-affiliation society, an individual’s religious, political, social, and economic affiliations all fall within the same group–often a clan leader in a single village. In a multiple-affiliation society, your religious leaders differ from your political leaders, and both differ from your primary commercial contacts. You also have many other affiliations that connect you with an even wider circle of people. Single-affiliation societies are much farther away from having modern political and economic institutions than are multiple-affiliation societies.