This paper develops a theory in which individuals can use one of two types of human/social capital to enforce contracts: “Local capital” relies on families and other personal networks; “market capital” relies on impersonal market institutions such as auditors and courts. Local capital is efficient when most trading is local, but only market capital can support trading between strangers that allows extensive division of labor and industrialization. We show that economies with a low cost of accumulating local capital (say, because people live close together) are richer than economies with a high cost of accumulation when long distance trade is difficult, but are slower to transition to impersonal market exchange (industrialize) when long distance trade becomes feasible. The model provides one way to understand why the wealthiest economies in 1600 AD, China, India, and the Islamic Middle East, failed to industrialize as quickly as the West. We report an array of historical evidence documenting the pre-industrial importance of family and kinship networks in China, India, and the Islamic world compared to Europe, and the modernization problems linked to local capital.

 If consumers become pessimistic about the state of the economy, can there be a slowdown in output, even if their pessimism is not based on economic fundamentals? A recent class of macroeconomic models shows the answer is yes, if there are “strategic complementarities” and multiple equilibria. In this paper we investigate the link between consumer confidence and economic fluctuations for the period 1953-1988 using vector autoregressions. In all models, after controlling for variables that proxy for economic fundamentals, the hypothesis that consumer sentiment does not cause GNP (in the Granger sense) can be rejected. Variance decompositions suggest that consumer sentiment accounts for between 13 percent and 26 percent of the innovation variance of GNP.