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.
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Top reviews from other countries
Athan
A textbook, but one I enjoyed reading
Reviewed in the United Kingdom on November 12, 2013
Standards Geek
The institutions went missing ...
Reviewed in Japan on March 15, 2016
