Economic Change – 3

This is the third and penultimate post in the series on Understanding the Process of Economic Change. In the previous posts, I presented Douglass North’s ideas on the role of knowledge and institutions on economic change. In this post, I review his ideas on the effect of the demographic change, order, efficient markets, impersonal exchange, and political factors on the evolution of the economy.

The entire review is now available on Dianoetic.


While not sufficient, order is a necessary condition for economic growth because its lack increases uncertainty and the costs. Its persistence can be understood by considering that beliefs are both normative and positive, that we not only have a view of society’s working but also of how it should be working.

Binding rules are necessary to establish and maintain order. The rules are binding if

  • “the same people play the same game with the same pay-offs and risks”
  • “the uncertainties about the future remain constant.”

The maintenance of political order during economic change requires:

  • “A shared belief system about the legitimate ends of government and the rights of citizens”.
  • “Successful constitutions limit the stakes of politics in part by assigning citizen rights and placing other limits on government decision making”.
  • “property and personal rights must be well defined so that it is evident to citizens when these rights are being transgressed.
  • “The state must provide credible commitments to respect these rights, thus providing protection against opportunism and expropriation by public officials.”

A key challenge in establishing order is to overcome negative cultural heritage. It is more difficult to establish consensual orders in societies with a significant history of disorder. In contrast, societies with the history of order and stable institutions, recover from disorder more rapidly.

Demographic change

The evolution in the public health played an important role in the economic development and evolution/revolution. It significantly improved the physical characteristics of human beings and their mental abilities.

Personal and impersonal exchange

North views the shift from personal to impersonal exchange a vital factor for the growth of large economies. This shift, however, cannot be achieved rapidly, because of:

  • The genetic architecture evolved from million years of being hunter/gatherers, that favours personal exchange.
  • Eventual mental adjustment, “indoctrination”, to impersonal relationships
  • The development of necessary mechanism to enforce impersonal agreements
  • Creating a strong but limited polity to enforce property rights at low cost

“Clientelism” stems from an institutional matrix that does not promote “productivity-improving activities”. It is the result of the keeping the institution of personal exchange in a large economy.

Efficient Markets

Every market, particularly capital markets, require specific institutions to provide incentive structure. These institutions need continual evolution to maintain efficiency and support economic change.

To maintain efficient markets, these points should be considered:

  1. Alterations in the performance characteristics of a market require an initial understanding of the source(s) of such change.

  2. “Successful” alterations designed to improve market performance require the correct theory of the overall process of change.

  3. Implementing that correct theory entails that the key players (that is entrepreneurs in a position to alter that market structure) possess such theory and are willing and able to act upon it.

  4. Where the alterations entail changes that must be enacted by the polity, there is an additional hurdle in enacting such political policies. This additional hurdle is that the existing institutional structure will have spawned organizations with a stake in that existing institutional structure and such organizations will attempt to thwart the changes. (p. 125)

Political factors

The political factors that led to Europe’s scientific, technological, and artistic developments are:

  • Fragmented political bodies that led to creative competition
  • A common belief structure (Christendom)
  • Information and transportation connections

Formal rules can create a stagnating condition for economic growth. The best time to change them is when the organisations supporting the status quo are weakened, e.g. due to poor performance or corruption.

In the short run, an authoritarian ruler can have a better chance of improving the economy. However, centralised political controls go hand in hand with economic monopolies. Thus, in the long run, a consensual polity is necessary. Implementing such system requires time and goes beyond simple formal rules.

“The four “ideal” [political] components can be restated as follows:

  1. an institutional matrix that produces a set of organizations and establishes a set of rights and privileges;

  2. a stable structure of exchange relationships in both political and economic markets;

  3. an underlying structure that credibly commits the state to a set of political rules and enforcement that protects organizations and exchange relationships;

  4. conformity as a result of some mixture of norm internalization and coercive enforcement.” (p. 158)

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