A Lecture on Economic Institutions
In the lectures introduction, North defines economic history as the performance of economies through time. Norths lecture is focused on the importance of institutions and time in determining economic performance, something that North claims to be usually overlooked when developing economic policies. To start off the discussion, the author provides an analytical modification of the neo-classical theory that we have today. He explains that the neo-classical theory is deemed to be inappropriate or not enough to produce the right policies that could encourage economic development. This is because, although the theory can explain the operation of the markets, it could not provide an understanding on how the economy develops. The neo-classical theory includes erroneous assumptions that economic institutions and the element of time are not important. The framework that North lectures modifies the rationality assumption of economic performance and includes the element of time as a consideration.
One of the goals of this lecture is to contribute a theory on the movement of the economy that could evaluate analytically the way that economies grow or move as time passes by. North discusses in his lecture how institutions form the incentive structure of a society and how political and economic institutions determine the performance of the economy. He also emphasizes in his lecture the reality that time is a factor that covers the learning process of people thus, it affects the way these institutions evolve.
Norths work is both thorough and well written because he carefully explains point by point the role of institutions to mans decision making capabilities. In one part of the lecture, he focuses on defining the nature of institutions and how they really influence economic performance in order to establish their role in the way the world operates. Institutions are the man-made constraints of human interaction, such as rules and laws for the formal setting and behavior and conventions for the informal setting that determine how a society is run and defines the incentive structure for societies and specifically economies. Political and economic institutions are major key players of the development of the economy and the actions that take place in the interactions in the society.
After clearly defining the role of institutions in the performance of the economy, North further ponders on what initiates institutional change and how these movements impact the whole economy. This part of the lecture is one of the most important highlights of his work. He describes the nature of institutional change in order to explain why some economic policies are effective for one country and senseless for another. Change is triggered by the evolving needs of the economys key players and whatever bargaining power they have to secure good contracts. To further explain his idea, North notes in his lecture all the key players of the economy that greatly affect the nature of institutions, namely entrepreneurs and the organizations. The former refer to individual persons while the latter are groups of people who are brought together by a common trait, interest, or objectives and are usually very influential in the growth of the economy. Organizations are the result of whatever opportunities institutions make possible for the people because they are dependent on what is allowed by the law or the norms of behavior. According to North, it is the interaction between institutions and organizations that shapes the institutional evolution of an economy. The relationship of institutions and organizations dictates the well-being of the economic movements in a society. Sometimes, rules are reconstructed and standards of behavior are modified to pave way for the continuous changes in the economy. Individuals and organizations usually engage in altering contracts to improve their status in life and to match the growing choices and decisions brought about by economic changes. When this happens, institutions change or adjust based on the requirements of the altered contracts.
North places significant emphasis on the relationship of institutions in the decisions or preferences of the key players in the economy because this is a major factor in establishing what contributes to the performance of the economy. Yet, North does not also miss out why it is important to also understand the nature of human learning. He stresses that development is only achievable with learning, and the beliefs and abilities that people hone through the education they get either genetically or through daily experiences are crucial in dictating how they form their contracts and how they use rules or norms in the economy. He also emphasizes that time helps collective learning to be acquired and utilized.
Norths lecture stresses that having a cognitive approach to economic institutions helps people improve their understanding of the past economic performance. An institutional approach to economic history, one that understands the relationship between institutions, technology, and demography in the process of economic changes, could make a complete theory of economic performance possible. Since altering institutions is a very complex matter because economic institutions have different functions from political institutions, economic history will help people to assess what contributes to economic stagnation or failures. This would make them more learned in comprehending the direction of the performance of their economy. North notes that there were other economists before that related the crucial connection between institutions, transaction costs, and neo-classical theory and that these are topics that are not new yet also insufficiently dealt upon. In his lecture, North simply expands the idea that since transacting is costly in the world we are living in, therefore, institutions really matter in the economic performance of the society. One of Norths most significant contributions revolves around the fact that if formal rules of one economy are forced upon another societys economy that has different informal norms and enforcements, this would not necessarily result in good economic performance. Quite the contrary, it could even lead to further downfall of the countrys economy.
However, North also asserts in his lecture how informal institutions, such as the conventions of people, can be favorable to economic growth even when formal institutions are unstable.
Norths work is important because it introduces the institutional or cognitive approach in evaluating the economic problems and policy development measures of contemporary time. He mentions in his lecture that this is where the neo-classical theory fails. Towards the end of the lecture, he enumerates several implications of the approach he developed in his work. First, he reiterates that the combination of institutions, which are composed of formal rules and informal norms, and the characteristics of their enforcement are the significant reasons for the form of economic performance. He highlights here how the formal rules used by the superpower nations of the world fail in third world countries because they do not have common informal norms of behavior. The second implication tells readers that an essential part of development policy is the creation of polities that will create and enforce efficient property right.
Accumulated education, institution formation, and belief systems that have developed through time are essential because they shape how people would decide and make choices for the economy. Lastly, North emphasizes in his work that the key to a long-running growth trend in the economy is adaptive efficiency. Therefore, economic history and assessment of past economic events help create a better understanding of economic performance.
The discussion presented by North in this lecture has been further developed by other economists and philosophers. His theory has been used in several other studies and has also been expanded to match the movements of the economy since the lecture won the Nobel Prize in 1993. Norths explanation about institutions has been exceptionally important to several other research studies related to economic growth. Even more than a decade after this lecture, his definition of institutions is still being cited and used, such as the study of Daron Acemoglu and associates in 2004 entitled Institutions as the Fundament Cause of Long Run Grown which makes use of Norths description of institutions in their study that applies to the situation in Koreas divisions and the European colonization in the 15th century. They further expanded on their study where North and other scholars of economics lacked in theory development such as the lack of crucial comparative static results that could explain other elements of economic institutions that North did not tackle in his 1993 lecture.
Norths theory is useful in any part of the world. M. Idrees Khawaja and Sajawal Khan of the Pakistan Institute of Development Economics, Islamabad also used Norths theory on institutional changes in their 2009 paper entitled Reforming Institutions Where to begin which they claim has the most widely cited definition of institutions. They reviewed Norths work in their paper and expanded it as well to provide a more contemporary version of the theory.
Douglas North is a renowned name in the field of economics because of his theory that has proved to be useful and informational. His work has encouraged the cognitive approach of the theory of institutional change that has explained and helped tremendously the analytical evaluation of economic performance. At the end of his work, he emphasizes the need to continue conducting research in order to enhance economic theories for the future. He ends his work with the hope that his Nobel Prize would be an additional encouragement for the enrichment of economic theories.