Institutions, Institutional Change and Economic Performance

Citation

North, D. C. (1990). Institutions, Institutional Change and Economic Performance. Cambridge University Press.

Chapter Summary

This is a short book: the text runs to about 140 pages in three parts and 14 chapters, followed by references and an index. In the preface North describes it as the outline of a theory of institutions and institutional change. Its central concern is human cooperation, specifically the cooperation that lets economies capture the gains from trade, and it asks why some economies develop institutions that support growth while others develop institutions that produce stagnation. Part I examines the nature of institutions and the role of transaction and production costs, Part II sets out a theory of institutional change and path dependence, and Part III draws implications for economic theory and economic history.

Part I: Institutions

Chapter 1: An Introduction to Institutions and Institutional Change. Institutions are defined as the rules of the game in a society, the humanly devised constraints that shape interaction and structure incentives. North argues that neither economic theory nor cliometric history has had an analytical framework for institutions, and says the book aims to supply one.

Chapter 2: Cooperation: The Theoretical Problem. The chapter opens with the tension between neoclassical theory and the observed performance of economies, pointing to organisations such as the medieval manor, the Champagne fairs and the bazaar market, whose persistence the frictionless theory does not explain.

Chapter 3: The Behavioral Assumptions in a Theory of Institutions. North questions the standard assumptions of utility maximisation and rational choice: motivation is more complicated and preferences less stable than assumed, and actors do not hold true models of the worlds they choose in.

Chapter 4: A Transaction Cost Theory of Exchange. The costs of transacting come from the cost of measuring the valuable attributes of what is exchanged and the cost of protecting rights and enforcing agreements. These costs are the source of economic, social and political institutions.

Chapter 5: Informal Constraints. Codes of conduct, norms of behaviour and conventions make up most of the constraints on everyday choice, even in modern economies where formal rules are prominent.

Chapter 6: Formal Constraints. Formal and informal constraints differ by degree along a continuum from taboos and customs to written constitutions. The chapter covers the shift to written rules and how formal rules can complement, modify or replace informal ones.

Chapter 7: Enforcement. Enforcement is seldom perfect, because measuring contract performance is costly and because enforcers are agents with their own interests.

Chapter 8: Institutions and Transaction and Transformation Costs. The chapter gathers the argument so far: institutions and technology together determine transaction costs, and institutions also bear on the cost of transforming inputs into outputs.

Part II: Institutional Change

Chapter 9: Organizations, Learning, and Institutional Change. Organisations and their entrepreneurs are the agents of change. The chapter returns to the distinction between institutions and organisations and shows how organisations, pursuing their objectives within the institutional framework, incrementally alter it.

Chapter 10: Stability and Institutional Change. Change is typically a marginal adjustment to a framework of nested formal rules, informal constraints and enforcement that is stable enough to make complex exchange possible.

Chapter 11: The Path of Institutional Change. The chapter asks why societies diverge and why economies with persistently poor performance survive, drawing on evolutionary ideas and developing path dependence.

Part III: Economic Performance

Chapter 12: Institutions, Economic Theory, and Economic Performance. North asserts that institutions are the underlying determinant of long-run performance, specifies what neoclassical theory must change to incorporate them, and explores a dynamic theory of long-run change.

Chapter 13: Stability and Change in Economic History. The chapter turns the theory on history, asking what combination of institutions captures gains from trade and why some forms of exchange are stable while others become more complex and productive.

Chapter 14: Incorporating Institutional Analysis into Economic History: Prospects and Puzzles. The final chapter asks what difference institutional analysis makes to writing and reading history, arguing that it permits a better story than the earlier pre-cliometric institutional history built on bits and pieces of theory.

Key Concepts

Chapters 1–4

• Institutions: the formal and informal constraints that structure human interaction.
• Institutions versus organisations: rules of the game versus the players that act within them.
• Transaction costs: the costs of measuring what is exchanged and of enforcing agreements.

Chapters 5–8

• Informal and formal constraints: customs and conventions at one end, written laws and constitutions at the other.
• Imperfect enforcement: the reason contracts are incomplete and informal constraints matter.
• Transformation costs: the costs of production, shaped by institutions as well as technology.

Chapters 9–11

• Incremental change: institutions change through marginal adjustments by organisations and entrepreneurs.
• Path dependence: the persistence of institutional patterns, including those with poor performance.

Chapters 12–14

• Dynamic theory of long-run change: the goal of building institutional change into economic theory.
• Institutions in economic history: using the framework to interpret historical performance.

Critical Analysis

Strengths

• Brevity and focus. A three-part argument in 14 short chapters: institutions, then their change, then their consequences. Each chapter is short, between about six and thirteen pages.
• A framework for several fields. North presents the work as a framework for economic theory, economic history and wider social science. Stanley Engerman, quoted on the publisher's page, describes it as stimulating and likely to influence economic historians as well as political and other social scientists.
• Challenges to standard assumptions. The chapters on cooperation and behavioural assumptions explain why the framework does not rest on frictionless exchange and fully informed actors.
• Reception. Paul Pierson, in World Politics, noted that it grounds the analysis in rational choice and stresses that institutional arrangements, once adopted, can lead rational actors to collectively suboptimal behaviour.

Limitations

• Programmatic character. The preface calls the work the outline of a theory, and Chapter 12 acknowledges that some pieces of the puzzle are still missing. It is a framework to be built on, not a finished theory.
• Date. Published in 1990, it predates the formal political-economy models and the quantitative institutional history that followed.
• Concision. With chapters of six to thirteen pages, each idea is introduced rather than developed through extended case studies, and the closing chapter's title, "Prospects and Puzzles", signals that applying the framework to history is left largely open. The book works best with case studies alongside.

Where It Fits in the Course

North's book is the conceptual statement of the new institutional economics in the economic history list. For a newcomer the more accessible entry points are Why Nations Fail by Acemoglu and Robinson, written for a general audience, and Koyama and Rubin's How the World Became Rich, which surveys the main explanations for growth. Neal and Cameron's A Concise Economic History of the World and Baten's edited A History of the Global Economy supply the historical narrative against which the framework can be tested.

Acemoglu and Robinson's Economic Origins of Dictatorship and Democracy is the formal, game-theoretic treatment of a related question: how political institutions are determined. North suits a first reading for the concepts of institutions, transaction costs and path dependence; the monograph is the follow-up for readers who want the models.

How to Use This Book

The book suits advanced undergraduates and graduate students in economics, economic history and political science. Introductory microeconomics and some economic history are sensible background, and North develops his argument in words.

A practical plan:

• Core: Chapters 1 to 5 for the definitions and the transaction-cost logic, then Chapters 9 to 11 for the theory of change.
• Next: Chapters 6 to 8 for formal rules, enforcement and the link to costs, and Chapter 12 for the implications for economic theory.
• Application: Chapters 13 and 14 apply the framework to history; read them together with a historical case of interest.
• Alongside: a narrative economic history for cases, and the more recent literature on institutions for formal models.