Economic performance through time
Economic Performance through Time
Douglass C. North
Lecture to the memory of Alfred Nobel, December 9, 1993
Economic history is about the performance of economies through time. The objective of research in the field is not only to shed new light on the economic past but also to contribute to economic theory by providing an analytical framework that will enable us to understand economic change. A theory of economic dynamics comparable in precision to general equilibrium theory would be the ideal tool of analysis. In the absence of such a theory we can describe the characteristics of past economies, examine the performance of economies at various times, and engage in comparative static analysis; but missing is an analytical understanding of the way economies evolve through time.
A theory of economic dynamics is also crucial for the field of economic development. There is no mystery why the field of development has failed to develop during the five decades since the end of the second World War. Neo-classical theory is simply an inappropriate tool to analyze and prescribe policies that will induce development. It is concerned with the operation of markets, not with how markets develop. How can one prescribe policies when one doesn't understand how economies develop? The very methods employed by neo-classical economists have dictated the subject matter and militated against such a development. That theory in the pristine form that gave it mathematical precision and elegance modeled a frictionless and static world. When applied to economic history and development it focused on technological development and more recently human capital investment, but ignored the incentive structure embodied in institutions that determined the extent of societal investment in those factors. In the analysis of economic performance through time it contained two erroneous assumptions: one that institutions do not matter and two that time does not matter.
This essay is about institutions and time. It does not provide a theory of economic dynamics comparable to general equilibrium theory.1 We do not have such a theory. Rather it provides the initial scaffolding of an analytical framework capable of increasing our understanding of the historical evolution of economies and a necessarily crude guide to policy in the ongoing task of improving the economic performance of economies. The analytical framework is a modification of neo-classical theory. What it retains is the fundamental assumption of scarcity and hence competition and the analytical tools of micro-economic theory. What it modifies is the rationality assumption. What it adds is the dimension of time.
Institutions form the incentive structure of a society and the political and economic institutions, in consequence, are the underlying determinant of economic performance. Time as it relates to economic and societal change is the dimension in which the learning process of human beings shapes the way institutions evolve. That is, the beliefs that individuals, groups, and societies hold which determine choices are a consequence of learning through time — not just the span of an individual's life or of a generation of a society but the learning embodied in individuals, groups, and societies that is cumulative through time and passed on intergenerationally by the culture of a society.