Introduction

While constitutional economics has to be traced back to the studies on poli­tics by the Greek philosophers - first of all, Plato and Aristotle - the economic analysis of the constitutional themes has flourished since the seventeenth century.

The analysis of institutions upon which individuals and communities rely for their interactions is founded on two pillars: (i) following methodological individualism, the individual behaviour is the basic unity of analysis; and (ii) ‘the way the game is played’ represents the collective pre-requisite for the players’ strategies in any social interaction, so that social and market equilibria have a collective character (Arrow, 1994).

In being involved in social and market interactions, individuals face uncer­tainty due to the exogenous conditions given by the state of nature and to the possibility of opportunistic behaviour. A game-theoretic framework has there­fore become frequent in social sciences. The pay-off matrices of social interactions may take different forms - ranging from the well-known pris­oner’s dilemma (PD), to the ‘hawk and dove’, to the assurance games and so on - depending on the individuals interacting in society to respond to a variety of strategies, such as nastiness, free-riding, reciprocity and empathy. A ‘self­enforcing’ equilibrium outcome can be formalized in coordination games with conflict of interests, stemming from the individuals’ consensus on the economic and social advantages of regularity in social behaviour (Schotter, 1981). Whenever individuals are able to create an institution, whereby their mutual advantage overcomes the opportunistic behaviour implied by self­interested rationality, their social interactions avoid coordination failures. In a self-enforcing equilibrium, the incentive to cooperate is endogenous to the game itself, and there is no need for an external deus ex machina. It is also worth stressing that many social interactions are characterized by multiple equilibria (Aoki, 2002), so that each equilibrium is associated with one rule of the game, in combination with each individual’s strategy.

Institutions consist of formal (constitutions, laws and regulations), and informal (contracts, social norms and customs) rules of interaction. Self­enforcing equilibrium outcomes depend on the interplay between formal and informal institutions. The status of social equilibria is acquired by formal and informal rules of interaction through the explicit or implicit enforcement of a sanction, respectively (Marx, 1844 [1970]; North, 1990, 1991). To start with informal institutions, a well-known example is the ‘social capital’, a name for shared values, such as trust.

Informal institutions arise in the markets to foster cooperative agreements by counteracting uncertainty and opportunistic behaviour. The theory of ‘con­tractual incompleteness’ claims that contracts are imperfect because their clauses do not comprehend all future possible contingencies; moreover, courts are not usually in a position to verify their implementation. The Coasean view (Coase, 1961) of social and market interactions maintains that the decentralized organization of exchange relationships may be inefficient be­cause individuals are often burdened by high transaction (mainly, bargaining) costs. By reducing uncertainty on future spot market exchanges, informal rules sustain the adoption of cooperative strategies by individuals once the relevant information comes true. Otherwise, formal institutions have to inter­vene and organize exchanges by a centralized command.

In pre-modern Europe, intra-community agencies and enforcement mecha­nisms were decisive in building up and preserving the medieval merchants’ reputation along with the development of impersonal exchanges (Greif, 2001). Commercial law was born in the codes of conduct of the guild merchants and then improved by the lex mercatoria, the regulatory institution which ruled on commercial transactions in medieval Europe, protecting the security and the certainty of exchanges and preserving the markets’ functioning from abuse of dominant positions (Milgrom et al., 1990).

Important factors determining the outcome of social interactions are complementarity (the equilibrium outcome in one game depends on the way in which the equilibrium outcome is taking shape in another game) and path dependence (the choice made at a certain fork of an extensive-form game heavily impinges on the final outcome).

By using his socio-antropologic method, Polanyi has shown that the mar­ket is an artificial construction: it originates within the constraints created by the organization of the state previously agreed on by the society (Polanyi, 1957). The theory of ‘market failures’ explains the emergence in the last century of the ‘mixed’ economy, a structure composed by private firms oper­ating in the markets under regulations provided by public agencies, and public institutions devoted to allocative, stabilization and redistribution poli­cies. A huge amount of research work has been produced in the last decades on the size and the functioning of the public sector institutions in the ad­vanced countries. The more social capital is rooted in a society, the better formal institutions function. As a matter of fact, social capital makes the rules sustaining the cooperative outcome endogenously respected. Due to the spon­taneous commitment to laws and norms by the community at large, many suboptimal outcomes of the social games fade out (Coleman, 1990; Putnam, 1993). In societies characterized by more collectivistic values, the legal and public institutions are less decisive than the informal ones. In many Asian countries, such as Japan (Morishima, 1982) and China (Weitzman and Xu, 1993), social capital mainly consists of the reputational effects associ­ated with the respect of social norms.

Since informal and formal institutions happen to be closely interwoven, a flawed connection among them gives birth to inefficient rules of the game. Along with market failures, the political economy literature has analysed a series of government failures. In fact, government relations between voters (as principals) and politicians (as agents), as well as the behaviour of elected representatives, are often plagued with conflicts of interest and opportunistic behaviour, which also affect the functioning of the market economy. The question is to what extent and through which instruments constitutional rules are capable of constraining human behaviour both in the market and in the government. Let us then turn to formal institutions.