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Section Summary of Douglass Norths Nobel Lecture Economic

Performance through Time


Section I: Introduction
[1] We need an effective analytical framework through which to study the
performance of economies over time so that we can better understand
economic change.
[2] Neo-classical economic theory, in its effort to prescribe policies that
induce development failed to recognize that institutions and time matter in
analysis. Incentives determine the character or make-up of institutions.
[3] This essay helps scaffold an analytical framework that is capable of
increasing our understanding of the historical evolution of economies and
will help guide us in the ongoing task of improving the performance of
economies.
[4] The relationship between incentives and institutions determines
economic performance. Beliefs are influenced by learning over time,
determine our choices, and are passed on from generation to generation by
culture.
Section II: A summary of work done on the nature of institutions and
their impact on economic performance
[1] Institutions are made up of formal and informal constraints and their
enforcement characteristics. These three elements form incentive structures
of societies and, specifically, their economies. The interactions of institutions
and technology determine transaction costs that add up to production costs.
[2] The informational and institutional requirements necessary to achieve
efficient markets are stringent. Rational economic analysis assumes that
surviving players behavior will lead to correct models i.e. survival of
the fittest; those that have the best information.
[3] The discipline of the competitive market model implies that institutions
are designed to achieve efficient outcomes, and thus can be ignored in
economic analysis.
[4] Yet, we know that institutions are not necessarily created to be socially
efficient; ratherthe formal rules are created to serve the interests of
those with the bargaining power to create new rules. It is this bargaining

power that affects the efficiency of outcomes in a world with transaction


costs, not necessarily the rules per se.
[5] Transaction costs involve measuring the value and enforcing the
agreements related to the physical dimensions and property rights of goods
and services or the performance of agents. In economic markets, the level
of competition determines the transaction costs and judicial systems provide
coercive enforcement.
[6] Measuring and enforcing agreements in political markets is far more
difficult compared to economic markets, as even a well-informed constituent
is uncertain as to whether or not an elected official will make good on his
promises. Complexity of political, sociological and economic issues
inevitably leads to ideological stereotyping and shapes the consequent
performance of economies.
Section III: The nature of institutional change
[1] Institutions (the rules of the game) interact with organizations and
entrepreneurs (the players) to shape the evolution of an economy.
Organizations are made up of groups of individuals bound together by some
common purpose to achieve certain objectives and can include political
bodies, economic bodies, social bodies and educational bodies.
[2] Organizations reflect the opportunities provided by the institutional
matrix, i.e. the interplay of formal rules and informal norms.
[3] Economic change is an ongoing process that is a consequence of the
choices individual actors and entrepreneurs of organizations make every
day. These choices (or exchanges) are influenced by rules (for example,
contracts) that change over time. As the rules change, so do the institutions.
[4] Changes occur because individuals get new information and perceive that
they could do better. In the long-run, change happens because of
individuals and entrepreneurs of organizations learning.
[5] The rate of learning will reflect the intensity of competition amongst
organizations - which reflects scarcity - thus inducing organizations to
engage in learning to survive. The greater the degree of monopoly power,
the lower the incentive to learn.
[6] How fast change occurs depends upon the rate of learning, but the
direction of that change depends upon how people perceive the pay-offs to

acquiring different knowledge, i.e. are there positive incentives to learn and
change?
Section IV: A cognitive science approach to human learning
[1] History shows us that ideas, ideologies, myths, dogmas and prejudices
impact how we human beings learn. A question we must ask ourselves is: do
individuals always know what is in their self-interest and thus act
accordingly?
[2] Furthermore, is there a difference between the real world and the
decision-makers perception of and reasoning about it? How do we come to
make decisions?
[3] The analytical framework we must build should originate in an
understanding of how human learning takes place. This way, we can come
to better know how people make decisions when faced with uncertainty.
[4] Experiences and language help us form mental models to explain and
interpret our environment, which are subsequently categorized within our
minds. These mental models, categories and our interpretation of our
environment evolve as we get feedback from our experiences and come into
contact with others ideas in short, learning.
[5] Our capacity to order and reorder the mental models helps us make
space available to process other information. Furthermore, our capacity to
use analogies reflect creative thinking and the ideologies and belief systems
that underlie the choices humans make.
[6] A common cultural heritage helps prevent divergence from mental
models that people in a society have and provides a means of internal
communication and shared explanations for phenomena outside the
immediate experiences of the members of that society. It is from this
circumstance that belief structures are created.
[7] Belief structures get transformed into societal and economic structures
by institutions both formal and informal norms of behavior. Institutions
are the external (to the mind) mechanisms individuals create to structure
and order their environment.
Section V: An institutional/cognitive approach to economic history
[1] There is no guarantee that the beliefs and institutions that evolve
through time will produce economic growth.

[2] Tribes different circumstances determined different institutional


frameworks, which were passed down from generation to generation and
formed cultural continuity.
[3] As societies became more complex and human beings become more
interdependent, their levels of economic growth were determined by the
evolution of their institutions. If the institutions facilitated impersonal
exchange they grew economically if not, they remained stuck.
[4] Collective learning forms culture, which determines path dependence
or, how much the past influences the present and the future. Societies
that get stuck embody belief systems and institutions that fail to confront
and solve new problems of societal complexity.
[5] A societys collective learning may be determined by 1) how the belief
system filters or interprets information gained from experience and/or 2)
different experiences that confronted people at different times.
[6] Institutions affect the acquisition of pure knowledge, or existential
truth, through scientific research.
[7] We as human beings have learned how to progress economically over
time, but explaining 1) why material well-being is the exception rather
than the rule and 2) the pace and direction of economic change throughout
history has proved to be quite difficult.
[8] If we represent the human experience as a 24-hour clock, civilization
occurs around 23:56.
[9] If the last 10,000 years are represented as a 24-hour clock, modern
economic growth and its accompanying population explosion begin at about
23:25. Furthermore, most of this growth took place in Western Europe,
Britain and their overseas extensions.
[10] Over time, the pace of economic growth has varied and change has not
necessarily moved in one linear direction.
Section VI: Implications of the institutional/cognitive approach for
improving our understanding of the past
[1] The institutional/cognitive approach to understanding economic history
helps us understand that the conditions for economic growth dont
automatically evolve. Growth depends on cooperation between political and

economic institutions that facilitate low-cost transactions in impersonal


markets.
[2] When thinking about changes that took place in Europe from the dark
ages to the enlightenment, were just beginning to understand the
historical process of how a gradually evolving belief system in the context of
competition among fragmented political/economic units producing economic
institutions and political structure led to modern economic growth.
[3] Institutional/cognitive analysis helps explain path dependence, but
should not include a classical assumption of rationality. This is because
economies grow, contract and stagnate due to politics and belief systems
the behavior and outcomes of which are difficult, if not impossible to predict.
[4] The institutional/cognitive analysis should be integrated with studies of
demography and technological change so we can better understand
economic history.
Section VII: Implications for current development policies
[1] We should take an institutional/cognitive approach to development
problems, which will help provide us with a new analytical framework.
[2] Formal rules, informal norms and enforcement characteristics shape
economic performance. The rules may change quickly, but the rules are only
legitimized by the informal norms - which may only change gradually.
[3] We know that groups of people, or polities, determine economic
performance based on their creation and enforcement of rules, but we dont
yet know how to create or transfer effective policy for economic growth to
the developing world. Yet, we do know that behavior (i.e. informal norms)
must change to support and legitimize new rules and that long-run growth
depends on the development of, amongst other things, the rule of law.
[4] We know that long-run growth depends on flexible institutions that foster
adaptability to change, but we dont know how to create adaptive
efficiency in the short-run.
[5] We will be better able to understand economic change through time and
help economic theory deal effectively with new issues through an analytical
framework that employs historical evidence and institutional/cognitive
analysis.