Understanding the Process of Economic Change

Short introduction to the New Institutional Economics by Nobel laureate Douglass C North.
Professor Douglass C. North, Nobel Laureate in Economics in 1993 and pioneer of the New Institutional Economics school, explains his views on how economic change occurs, stressing the role of institutions. He argues that Western Europe and the United States have adopted their institutions so as to maintain continuous long run growth. But this ‘adaptive efficiency’ cannot be created in the short run in other societies.

Executive Summary

Static economic theories cannot explain a world of dynamic economic change

As people have gained control over the physical environment, uncertainties resulting from human interaction have increased.

The dominant beliefs of policy-makers result in’…the accretion of an elaborate structure of institutions, both formal rules and informal norms, that together determine economic and political performance.'(p.11)

Beliefs, which determine the institutional structure, lead to policies. But these policies alter perceived reality, leading to feedback changes in beliefs, in institutions and in policies.

‘…the culture of a society is a cumulative structure of rules, norms and beliefs, that we inherit from the past, that shape our present and that influence our future.’ (p.15)

Most economists believe models derived from the past can help find the right polices for the future. But if reality is constantly being changed by policy, novel situations may be created with which we cannot easily deal.

Western Europe and the United States have adapted their institutions so as to maintain continuous long term growth. But this adaptive efficiency cannot readily be created in the short run in other societies.

Economic history is a ‘…depressing tale of miscalculation’ (p.18): We do not understand reality, our belief systems are imperfect and the control tools are ‘…very blunt instruments.’

The ability to make radical change in a society depends on the way its beliefs have evolved and the degree to which those beliefs are amenable to change.

‘Any market that is going to work well is structured by deliberate efforts to make the players compete by price and quality rather than…by killing each other or other means.’ (p.23) But we do not know how to create the necessary political institutions.

1998, Occasional Papers 106, ISBN 978 0 255 36422 5, 40pp, PB

See also:

Paths to Property: Approaches to Institutional Change in International Development , by Karol Boudreaux and Paul Dragos Aligica, for an application of North’s ideas.

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