Economic Performance Through Time by Douglas North
North also states that neo-classical economic theory, fails to recognize that “institutions” and “time” matters in the analysis of economic performance. In addition, the relationship between institutions and incentives decides economic performance. Influenced heavily by learning over time, a culture makes choices, and these choices are passed on through the generations. This essay will help guide us in the “ongoing task of improving the performance of economies”, by providing a base of an analytical framework that will be “capable of increasing our understanding of the historical evolution of economies”.
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The second section is a summary of his work done on the nature of institutions and their impact they have on economic performance. We find in this section that institutions are made up of formal, (rules, laws, constitutions) informal constraints (norms and behaviors and self made codes of conduct) and enforcement characteristics (size, weight, and color). These three essentials create incentives for societies and their economies. Institutions and technology connections determine transaction costs that add into production costs.
However, North implies that “ the informational and institutional requirements necessary to achieve such efficient markets are stringent”. That rational analysis says that surviving “players’” will lead to correct models based on those that have the best information. In the discipline of the competitive market model entails that institutions are “designed to achieve efficient outcomes”, so it can be ignored in the economic examination. Yet, institutions are not socially efficient; to a certain extent the formal rules are made in interest of those with bargaining power to create new rules.
So, it is bargaining power that affects the outcomes in a world full of transaction costs, not the rules. We learn that transaction costs are determined by, measuring the value and inflicting the agreements to physical dimensions and property rights of goods. In outlook the competition level determines the transaction costs. North also says that measuring and enforcing political markets is more difficult than economic markets. This is because it is hard to guarantee that an elective official will keep good with his promises. Section number three is the nature of intuitional change.
It is implied here that institutions are the rules of the game that interact with organizations and entrepreneurs, which are the players to shape the evolution of an economy. Organizations are individuals bound together by some common purpose to reach objectives, which include political, economic, social and education bodies. Organizations expose the opportunities provided by the interaction of formal rules and informal norms or the “institutional matrix”. North states in short that economic change is a continuing process that is a result of the choices individuals of organizations make everyday.
These choices are influenced by rules/contracts that change over time. So as rules change so do institutions. These changes happen when a person individual receives new information and recognize that they could do better. So in fact changes happen because entrepreneurs of an organization are learning and innovating the organization. The speed of learning depends on the intensity of the competition amongst organizations. Meaning they have to learn and innovate to survive and surpass the competition. However, the direction of these changes, due to learning, depend on the “pay-offs” are they positive incentives to learn and change?
The fourth section North discusses a cognitive science approach to human learning. History shows that human being learning is impacted by ideas, ideologies, myths, dogmas and etc. So do decision makers act on their self-interest? How do we come to make decisions? North suggests that the analytical framework we must build should “originate in a understanding of how human learning takes place”. So we can better know how people make decisions when faced with doubt. Experiences and language help us form mental models to interpret our environment. These models evolve as we get eedback from our experiences and come into contact with others’ ideas. This is known as learning. Cultural heritage prevents divergence in mental models by using internal communicate to explain phenomena outside the present experiences of the members of that society. This is how belief structures are created. Belief structures, by formal and informal norms of institutions, get transformed into societal and economic structures. “Institutions are the external (to the mind) mechanisms individuals create to structure and order their environment.
Section five is about an institutional/cognitive approach to economic history. Douglas North initially says, “There is no guarantee that the beliefs and institutions that evolve through time will produce economic growth. ” He describes that tribes with different experiences establish different institutions, which pass down through the generations and formed cultural stability. As societies evolved, their economic growth became more determined by the advancement of their institutions. To grow economically they had to make possible “impersonal exchange”. If no they remained “stuck”. Collective learning” forms culture which determined how much the past influences the present and the future or “path dependence”. Also, North states that institutions affect the gaining of “pure” knowledge through scientific research. Human experience as a “civilization” started very late in the human timeline, and so did economic/population growth. Most of this growth took place in Western Europe and their overseas expansions. While looking at economic growth through time North notices that the pace does not move in one linear direction rather it vary.
The sixth section goes over the implications of the institutional/cognitive approach for improving our understanding of the past. This helps us understand that the conditions for economic growth do not automatically evolve. Growth depends on the relationships between political and economic institutions that practice low transaction costs. This institutional/cognitive analysis does help explain “path dependence” of an economy however, due to the human factor in institutions like politics and belief systems, because of behavior economic growth is very difficult to predict.
To help this prediction we must better understand economic history, which North does by integrating studies of demographic and technological change. The final section explains implications for current development policies. North believes that we should take an institutional/cognitive approach to development problems, this we help provide us with a new analytical framework. While the formal rules, informal norms and enforcement characteristics shape economic performance. The rules may change quickly, but the rules are only legalized by the informal norms that may change gradually.
North also recognizes that we do not know how to create effective policies for the “developing” world’s economic growth. However, he follows up by implying that their behaviors (informal norms) must change to support new rules and that growth depends on their development of law. Finally, this essay establishes that through the study of economic history and institutional/cognitive analysis, we will better understand economic change through time and help economic theory deal with new issues through.