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Institutions, Institutional Change and Economic Performance (Political Economy of Institutions and Decisions)

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These are strange times in the economics profession. Most economists insist upon representing actual economic systems with mathematical models that bear little resemblance to reality. The results of these models are often quite strange. Government deficits are offset by taxpayers who save more money in anticipation of higher future taxes. Monetary policy is neutral; it has no real predictable effects. We are in equilibrium in every phase of the business cycle. Investors might as well pick stocks by throwing darts. Economic analysis is judged by its formalism, not its realism.

This book by Douglass North is a refreshing change from `economics as usual'. Here the factors that matter most are real institutions and actual history. North draws upon the right kind sources for his theoretical underpinnings (Coase, Hayek, Ostrom, Olson, Veblen- yes Veblen too). North also focuses on an issue of primary importance- economic performance through time. How does economic development happen? Why does it happen in some nations and not others?

There are some important ideas here. We need to think in terms of adaptive efficency (p80-81). Incremental changes in institutions comes from entrepreneurs (p8). We should understand institutional change in terms of transaction costs, relative prices, and ideology (p86). North has constructed a theory of institutional change using a blend of common sense and subtlety that is rare in modern economics. This book should be required reading for all econ grad students.

There are some historical examples sprinkled through this book. Personally, I would have liked to see more history. But it is still the case that there is more history here than one typically finds in contemporary economics. Institutions, Institutional Change, and Economic performance is not easy reading, but it is easier to read and vastly more informative than the math models that most economists try to pass off as proper economic analysis.

North's work attempts to show how hard-rational choice theory and neoclassical economic theory are weak in that they argue that cooperation and coordination are not fundamental to transactions. North writes that in the "zero transaction-cost world, bargaining has no place, however, in the real world, institutions, bargaining and cooperation are necessary" (16).

The author argues that the rigidity of the human behavior described by hard-rational choice theorists is not practical in a real-world sense. For example, actors do not have perfect "computational power" and as such they don't have a perfect description of the world. Rather, the situations faced by actors are complex and uncertain. As such, transaction outcomes are unpredictable. North writes, "Uncertainties arise from incomplete information with respect to the behavior of other individuals in the process of human interaction" (25).

In order to protect oneself or maximize his or her individual utility, an individual must collect information regarding a transaction. The costs of transaction "consist of the costs of measuring the valuable attributes of what is being exchanged and the costs of protecting rights and policing and enforcing agreement" (27). Institutions are created to generate regular patterns in human interaction. Doing so decreases the costs of transaction, or "playing the game."

However, the game is never stable and as such institutions are malleable; they are capable of change. Yet the changes occur slowly, by increments. In the later chapters of the book, North takes a historical look at economic development, stability and change. Had all things been equal, transaction costs being zero, North argues that little diversity between economic systems would exist. North writes, "In a world in which there are no increasing returns to institutions and markets are competitive, institutions do not matter. If the actors initially have incorrect models and act upon them, they either will be eliminated or efficient information feedback will induce them to modify their models" (95). However, in real-world situations, institutions do matter and they are in continuous need of minor, or marginal, adjustments. In many ways, it is the behavior of the actors that make adjustments to the institution. North writes, "Incremental change comes from the perceptions of the entrepreneurs in political and economic organizations that they could do better by altering the exiting institutional framework at some margin" (8).

In conclusion, new institutionalism has emerged in response to the concentration on behavioral/rational choice theories in the discipline. The new institutionalism attempts to "bring the institutions" back in to political science. However, institutional scholars have evolved from the days of strictly studying the political systems of polities. The new institutionalism attempts to blend aspects of behavioral/rational choice theories with the importance of institutional structure and establish a new paradigm with which to study political phenomena.

I have a hunch that this is one of the kind of books such that only people whom have in a sense already specialized come upon it and decide to buy it. First: if you are one of these kind of people, the articles contained in this volume are well written and though not classics, could further your understanding of 'our' field. Second: if you are not already a specialist, there are other books by Douglass North and Mancur Olson that can better illustrate the general principles on which the economic/political hybrid field is based.... Olson's "The Logic of Collective Action" illustrates the development of institutions while Norths "Structure and Change..." shows how they have functioned throughout time...

If you ever wondered what new institutional economics is all about take this book. While it may be helpful to have an economics background the content is accessible to a wider audience. It is an absolute must for everyone who is interested in the interaction of political, social, cultural, religious, and historical elements in economic growth and policy. As a former student of North I love coming back to this book and everytime you get something new out of it.

The puzzle of the modern world is not that so many people are poor, but that so many are wealthy. How do democracies, with well-defined property rights and education for all com into place? In this Nobel prize winning work, North investigates some issues overlooked by most economists: the role of a society's institutions, defined as formal and informal constraints, varying from written laws to vague values (but important nevertheless) in a society. Economic theory is not able to explain the great differences in wealth between nations, argues North, and that is certainly a shame, because that would be the most interesting explanation it could possibly make. The solution is to include institutions into economic analysis.

Institutions determine transaction costs. In neoclassical economic theory, transaction costs are usually assumed to be zero (for reasons of comfort). North assumes transaction costs to make up half of the economy in a modern well-organized Western society with efficient institutions. A major reason for developing countries to be poor is that transaction costs are prohibitive, obstructing the benefits of trade.

North asks some extremely important questions in this book, but I was a bit disappointed that he didn't offer more answers. English not being my natural tongue, I found the book a bit hard to read. However, being very interested in the subject, I found it well worth the effort. Without a major (interest) in economics, you should probably enjoy some of the reviews instead. North's main answer to the main question, by the way, is that countries will prosper if the incentives created by their institutions motivate production, and not redistribution.

This is the great founding book in systematic and specific study of institutions as a determinant factor in the economic performance of a nation (or any other kind of polity). The author is a Nobel prize winner, and his book is characterized by an economy of words, as well as precission and clarity in his thought. Although it would seem obvious that institutions play a decisive role in economic performance, it hasn't been the case along the history of economic thinking. North begins by criticizing the cold and abstract Neo-Classical model, a la Robert Solow. Yes in fact, output is the result of the conjunction between capital and labor, plus the further addition of knowledge (technology) to the equation Q = K x L x (e). But this model is really effective only under the assumption of open and competitive markets, perfect and equally accessible information, and zero transaction costs. We know the real world is not like that. We now know also that "rational choice behavior" is neither absolute nor unanimous, and that each "actor" defines the "rationality" of his choices according to his view of the world and himself.

There are two kinds of institutions: formal (laws, codes, public policy, business policy, etc.), and informal (traditons, religions, modes of organization, family and social habits). Both are equally important, for they determine the rules of the game. In turn, rules determine what kind of knowledge is worth acquiring, what activities are profitable, and how to relate to others, which, in turn, determines economic performance. An innovation-rewarding society will tend to be technologically advanced, whereas a conformity-rewarding society will stagnate. Another important statement of the book is that institutions change in a marginal and incremental way. Even after revolutions and radical changes in political regimes, informal institutions tend to persist and in any case they change very slowly. North uses the example of the Russian Revolution: even though it is most likely the most radical and sudden social change ever experienced, there is still much of Tsarist Russia in its contemporary society, after the Soviet regime came and left. Tocqueville made the same observation about the French Revolution in his masterful "The Ancient Regime and Revolution": France ended up with an Emperor and several kings after the republican bloodshed and well into the XIXth Century, and social change came about slowly.

By generating winners and losers, institutions create "path dependence". Even when it is clear that change is needed, those who profit from the status quo (the rich and powerful), will stop or obstruct change. North puts forth the case of the Americas, the Anglosaxon and the Hispanic, to illustrate how, in spite of the fact that many Latin American nations practically copied the American Constitution after achieving independence, the heritage of the decadent and stagnant Spain persists to this day in their instititutions.

This is easily one of the most relevant books to read when trying to understand the world's economy (crisis and all). As a further example, although it looks like China has changed overnight, it is most likely that's not the case in institutional terms, and soon China will face the dead weight of its culture versus economic progress. Change does happen, and there may be some kickstarters, but in the long run institutions change in an incremental and slow way.

Douglass North is an excellent writer, and this book is the amazing culmination of a lifetime's work in the area known as New Institutional Economics. This school or tradition is concerned with the role institutions play in the functioning of economies, and in particular, how they influence economic performance. Institutions are defined as rules or constraints, both informal (social conventions, habits, norms, etc.) and formal (legal rules and regulation), on human behavior. Rules, however, only provide the framework for action, and it is here where Douglass North brings in "organizations", which are responsible for determining the ways in which those "rules" become articulated, accepted (internalized) and enforced.

A lot is covered in this book, but some general themes and arguments can be gleaned from the very short and immensely accessible number of pages. Perhaps most importantly, North argues in this book that conventional concepts like economic efficiency, cooperation, perfectly defined and costlessly enforced property rights, "frictionless exchange", costless information, and economic rationalism are by no means "given" in the standard economic modeling framework. These all depend on the "stability" of the institutions that exist in society. Stability, in turn, also depends on the ability of the agents responsible for measurement and enforcement to reduce transaction costs so that economic performance can be improved. This itself is by no means "given", because the State (the agent commonly assigned the task of enforcement) typically acts in ways that make property rights less secure, and hence raises transaction costs.

If all of this sounds interesting, then Douglass North's book is perhaps the best source to consult on these matters. His prose is eminently readable, and he is a pleasure to follow as he tells his story in fascinating detail. I have explored other books that deal with similar topics, but I still regard this book as the most edifying.

An intriguing book on the so-called neo-institutionalist approach by one of its long-time proponents, Douglass C. North. Written without accessive jargon, this book is accessible to any intermeidate level student of Economics and Political Science. North argues that institutions (laws, rules, regulations) in their fromal and informal varieties determine economic performance. North has an almost guru-like status in the eyes of the World Bank. Third World countries remain poor, argues new institutionalism, because their institutions foster corruption and distort incentives. But what is the solution?

It is hard to imagine that one can graft institutions. How can the rules that function in the U.S. function under all kinds of social and political circumstances? The other troubling point is that it is still hard to integrate this approach with mainstream economics. A serious economist today is trained to shy away from anything that cannot be mathematically modeled. More troubling, however, is the following: neo-institutionalism argues that rules, laws, and regulations structure incentives, which in turn determine economic performance. A thoughtful person probably guessed this a long time ago based on common sense--one does not need a scholarly approach to advocate this position. "Incentives are the underlying determinants of economic performance," says North (p. 135). It is hard to disagree.

This is a really good and insightful book for anyone interested in economics, especially as it relates to determining factors in economic growth. In about 150 pages, North presents an interesting and thought provoking theory of economic growth.

Douglass North is an amazing writer. If you are purchasing this book, you probably already know what this book is about and its impact. This book, I would argue is largely responsible for his receiving the Nobel Prize in 1993.

His new-institutionalist view links together history, economics, political science, sociology, and every other social science. This book truly inspired me to specialize in institutional economics. Every social issue can be approached from the institutional perspective, namely that institutions determine actions and the market determines institutions. Though my professors are all old institutionalists, they agree this is the best book by far on the subject and most research papers in the subject thus reference this book.

For more information on New Institutional Social Science, visit the website at http://cniss.wustl.edu/people.html