Summary of Economic performance through time

Prepared By

Economic performance through time

Douglass C. North

History consists of performance of economies and changing analytical frameworks for the
behaviours of institutions. Main theories are general equilibrium theory and the theory of
economic dynamics which suit the current position of economy. As neo classical theory does
not fulfil the requirement of an analytical framework to be considered today that is the main
tagline which states performance evolve over time. We need to understand the need of
analysis in the markets and accurate frameworks to measure them, with that the need of time
and changing behaviours of economies. The consequences if the change and learning should
be highlighted.

The institutions are made by the society with different formal and informal set of perspectives
that are laws constitutions and rules, norms behaviours and conduct in the society. They form
up economies structure by defining the transaction cost and transformation cost that is the
cost of production. By the neo classical perspective the transaction cost is zero and market
clears at this point. But this cannot happen according to Wills and North (1986). Today the
market clearing situation is made by simultaneous trading high competition which increase
the profits of trade. This is possible by the instinct of how to achieve the objective and the
disciplines to invest and earn. In the real-world people trade subjectively with partial
information and subjective models so the cost of transaction affects the bargaining powers
and create new rules by the time. The cost of transaction measures what is being exchanged
that is real and they have physical attributes that affect and costs to measure. The political
enforcement defines the property rights, and it is nearly impossible to find efficient and clear
economic market with full flow of information and cleared transaction.

Evolution of Economy is shaped by the interaction between organizations and institution. A

group of individuals with same goal make an organization when they are bonded together.
We make take many examples such as political bodies, economic bodies, social bodies, and
educational bodies. An organization that emerges usually reflects the morals and rewards that
are provided by institutional matrix. Productive institutional matrix makes productive
organizations. The choices made by the entrepreneurs, and individuals initiate the process of
economic change. Usually, these decisions are routine in nature but sometimes re-contracting
and new contracts are formed between individuals and organization, thus making the norms
of behaviors be modified and altered and moreover this thing leads to the alteration of
institutions. These changes or modifications occur due to this fact that individuals believe that
due to restructuring they could increase the output or do better, the long run change is the
learning of the individuals and of organizations. Although curiosity leads to learning, but the
gradient of learning is proportional to competition amongst the organizations. The greater the
degree of monopoly power the lower the incentive to learn. Although economic change is the
function of rate of learning, but rate of learning is a function or derivative of payoffs.

Although rational choice approach says that individuals know what is in their best interest
and in the highly developed markets it may be even true, but in the uncertain outcome
situations this idea is not applicable. Herbert Simon has stated, ‘If… we accept the
proposition that both the knowledge and the computational power of the decision-maker are
severely limited, then we must distinguish between the real world and the actor’s perception
of it and reasoning about it. We must construct a theory (and test it empirically) of the
process of decision. Our theory must include not only the reasoning processes but also the
processes that generated the actor’s subjective representation of the decision problem, his or
her frame. (Simon, 1986, pp. S210-11)’. Our analytical framework built must take human
learning in consideration and try to understand it. Learning means the perception of signals
from the environment and making an outcome of those experiences so that one may
remember as to what happened when a specific reaction was produced. Learning process
starts from birth and keeps on going as long as it takes. Thus, the mental models may be
continually redefined with new experiences, including contact with others’ ideas. A human
mind keeps on reordering and ordering the mental models so that new spaces of learning are
constantly available and that evolves, this constant change underly and point to new choices
which a human being make. To reduce the divergence in the human mind a common cultural
heritage provides the means for the intergenerational transfer of unifying perceptions. There
is unique bond between mental models and the institutions. Mental models are the internal
representations that individual cognitive systems create to interpret the environment;
institutions are the external (to the mind) mechanisms individuals create to structure and
order the environment.

North argues that whether over a period an institution will evolve is a belief that has no
precedent. He justifies this statement further by giving examples of tribes that went through
long-run political change. Those tribes witnessed different physical environments, languages,
and experiences. The language and mental capacity of each tribe comprised of informal
constraints of their institutions which were later on passed down from one generation to the
next in the form of customs, taboos, and myths. With time, the aforementioned tribes
underwent specialization and division to grow and survive. They evolved into what we know
today as economies and polities. However, not all tribes flourished unanimously, some faced
hardships. This occurred because in order to flourish as an economy, the tribe had to develop
interdependent institutions, and most tribes did not adhere to this. Instead, most of them got
held up and did delve into the very essential impersonal exchange needed to grasp the
productivity gains that came along with specialization and interdependency.

North then comes to the fact that these abovementioned tribes act as a precedent for people in
our society to take notes on because what they provide us is “experience” through the passing
of time (both past and present). North also mentions collective learning which consists of
experiences and changes that have withstood the test of time and are instilled in our language,
institutions, technology, basically our whole lives. What we are able to learn today is by the
grace of our past generations and what they learned, it is an incremental and slow process that
is filtered by the present geological and cultural landscape of the people. That being said it is
not imperative that these past experiences will pave for an economy to institutionalize and
grow successfully as they might not answer your modern-day problems. The societies that
fail in the modern world are the ones that keep on looking in the past to find answers to the
problems that they are facing in the present day; it is a good place to look but it is certainly
not the last place to look. We, human beings need to diversify our knowledge of cumulative
learning.

Although modern economic growth is directly associated with rewards and punishments,
there is a huge role of creative developments throughout the world too. There is a big gap of
thorough research in the relationship between institutional structure, belief systems, and pure
knowledge that gives rise to creative developments. Incentives are the one thing that can in
actuality define economic performance through time. We can clearly see that that what we
have achieved so far in terms of economic performance has been a matter of chance and luck.
We have failed again and again only to find approaches for our economies to only be
satisfactory and then we stop to praise ourselves. It took us 10 millennia to reach the current
state of our economies and yet more than half of the world is unaware of its economic
potential. Radical improvement in an economy can only be witnessed in very small parts of
the world and that too is limited to specific parts of the world, that knowledge has so far not
propagated to the whole world. How to divulge all such phenomenon to the world still
remains a game that has yet to be won.

North then paints a bleak reality by contrasting the whole timeframe of the world till the
development of agriculture in a 24-hour clock and then makes a point by explaining that only
the last 3 or 4 minutes of those 24 hours is the time when humans grew to be hunters and
gatherers, the rest of the time (which is a lot) we were a lost cause. Contrasting it to the time
of civilization doesn’t paint a very good painting either as economic growth remained slow as
civilizations rose and fell one after the other, However, one can see a rapid period of
economic growth but that is still in the last 35 minutes of the whole 24-hours. The growth in
those 35 minutes, lasting from 1750-1950, can be seen segregated in the western part of
Europe and Britain. This explains that economic growth has not been equal, there have been
long periods of stagnation for other economies in the world.

In section 6, North explains that the not-so-effective economic performance described

previously is in line with the institutional approach. Economies require low-cost transactions
and impersonal markets to be productively sustainable, Game theory provides all the
necessary variables to achieve that. To achieve this state of institutionalization, one needs not
only to create economic institutions but the creation of political ones that support the latter is
imperative as well. Economic and political institutions both played a role to some extent in
the successful development of Western Europe.

The second thing one can infer is that institutional analysis explains path dependence.
Stagnation or Growth in a respective economy can persist for a long time. The neo-classical
school of thought argues that one can alter the rules to change their economic direction from
stagnation to growth, but it is not those leaders or rulers have not tried to do that, but the lack
of institutions and belief systems hinder growth.
The third thing that this approach can make us understand the intricate relationship between
different institutions, technology, and demography. It defines that such an integrated
approach is crucial for good economic performance. North further argues that the puzzle of
successful economies is still incomplete as many variables and approaches are still to be
accounted for. An example would be Nathan Rosenberg (1976) and Joel Mokyr (1990) taking
into account technological change and its need to be integrated with institutional analysis.
North has taken the first step in integrating these two but achieving complete flawless
integration is still a long way to go.