Path-Dependent Rule Evolution

Abstract

Definition Path-dependent rule evolution occurs whenever the further change of formal or informal institutions is, at least to some degree, determined by the institutional history of a system. How rules emerge and change Different types of rules influence individual behavior. There are formal institutions, such as laws or self-adopted written rules of organizations (Furubotn and Richter 2005); there are informal institu-tions that are not captured in written form, such as social norms (Young 2008); and there are also habits or routines (Hodgson 2010; Vanberg 2002) that individuals themselves follow. A decision to implement and to follow such rules can be made consciously, but they can also evolve without any individual making a deliberate choice to change them. In any case, the evolution of rules is often path dependent. Path dependence exists, simply put, when past events and decisions have an influence on and limit the scope of the future evolution of a system (David 2005). A simple example is the decision-making of individuals who have a preference for social approval and who attempt to infer from peer actions what the socially desired behavior is. At the initial stage, let there be a range of behaviors with roughly similar individual payoffs, so social approval dominates the choice between them. In that case, it can happen that, given enough time, a vast majority of individuals coordinate on one type of behavior (Arthur 1994), which henceforth works like a social norm (Young 2008). It is important, however, that from the ex ante perspective, there were multiple possible equilibria, that is, various different kinds of social norms that individuals could have settled on. Path dependence implies that small differences in the early stages of the process, such as individuals randomly observing one kind of behavior rather than another, can have huge effects on the question which equilibrium is eventually chosen. From an efficiency-oriented point of view, the biggest problem is that the equilibrium of a path-dependent selection process may not be efficient (David 1985), simply because chance and other individual motives than efficiency have driven the process. It may turn out that a different kind of norm would be, for example, associated with lower transaction costs or a more efficient utilization of technology. However, path dependence often leads to a lock-in (Arthur 1989) where, given the status quo social norm, there are little individual-level incentives to deviate from the norm. A change in the social norm therefore requires a widespread change of individual expectations regarding the desired behavior. This can occur as a result of political interventions, but also through decentralized processes such as social communication. If the latter occurs, the result often appears on the surface as a relatively sudden tipping from one social norm to another (Young 1998). Some skepticism is however due with regard to the likelihood of efficient, deliberate changes of both informal social norms and formal laws through the political process. Path dependence in opinion-formation can lead to equilibria where publicly voiced political opinions, which are deemed false by a large majority of individuals, nevertheless dominate political discourse (Kuran 1995). Similarly, a majority of individuals can be easily locked-in believing factually false policy-related beliefs to be true and refusing to update them (Schnellenbach 2004). The fact that policy-making rests not on individual but shared beliefs (Denzau and North 1994; Bischoff and Siemers 2013), with very limited incentives for individuals to invest into holding factually correct beliefs, is therefore one factor that leads to a frequently observed persistence of inefficient rules. The evolution of the rules that govern society is therefore to be understood as an interdependent process where informal institutions affect the evolution of formal institutions and vice versa (North 2005). In order to overcome inefficient lock-ins, a careful institutional policy-making is necessary, although not always sufficient (Eggertsson 2005).