Published by EH.NET (February 2005)

Douglass C. North, Understanding the Process of Economic Change. Princeton: Princeton University Press, 2005. xi + 187 pp. $29.95/?18.95 (hardcover), ISBN: 0-691-11805-1.

Reviewed for EH.NET by Alexander J. Field, Department of Economics, Santa Clara University.

Douglass North’s latest book addresses fundamental issues in understanding change and variation in economic performance. Early North (Davis and North, 1971; North and Thomas, 1973) treated institutional structures as epiphenomenal — largely reflective of resource endowments or available technologies. In later books (North 1981, 1990) his views evolved, acknowledging that some persisting rule structures might be dysfunctional, and that ideologies and social norms could play a role in explaining such outcomes. In this, his most recent book, he delves deeper, exploring the cognitive processes whereby individuals construct mental models of the world, and how such processes can, in the aggregate, influence economic performance.

Those familiar with North’s prior work on institutions will find that this contribution shares many characteristics. Although critical of economics as it is practiced, he never engages in a jeremiad. North wants to point the way forward rather than become mired in criticism, and as befits a Nobel Prize winner in economics, he has recruited and absorbed the ideas of many prominent scholars, both inside and outside the discipline. As in the earlier works, there is little original research reported here. This is a work of synthesis.

The book has two parts. The first addresses “Issues Involved in Understanding Economic Change,” and the second, presumably with no objections from Bill Gates, “The Road Ahead.” On the dustcover Barry Weingast describes the book as “vintage North.” When we refer to a vintage automobile, or vintage wine, we often refer to something with a provenance at least two or three decades earlier, and this characterization is most applicable to the second part of the book. For example, chapter 10, “The Rise of the Western World,” is largely derivative of arguments first advanced in the early 1970s. But Part I of the book contains generally newer material, and for those who have not been following the latest developments in North’s thinking, this is a good place to catch up.

More so than in North’s writings from the 1970s, the claims of the book are modest. In the preface the author asks rhetorically whether “we can develop a dynamic theory of change” and answers “probably not” (p. vii), claiming as his objective the old German objective of verstehen, or “understanding,” a word which also, of course, figures prominently in the book’s title. But “understanding” is not enough if we truly aspire to do social science. “Understanding” opens the door to “just so” stories that may be comforting and enjoyable to read, but have the appearance of giving us more insight than they do. One searches in vain in this book for hypotheses that could be tested against historical or contemporary data, and although North has, I think, situated the play in the right arena, he has done little to move the explanatory ball forward. Thus the book is ultimately disappointing for those seriously interested in these issues.

Let me briefly summarize what I see as our current state of knowledge. First, there are a number of universal features of human societies which almost certainly have a genetic substrate, either in terms of innate behavioral predispositions or differential preparedness to learn in certain directions. North seems to be on the same page here, acknowledging, for example that our abilities to cooperate in small groups, and our receptivity to religious/supernatural explanations have a biological basis (pp. viii-ix, 28-29, 45, 72). As is probably appropriate for a book of this scope, he avoids discussion of the processes or mechanisms of natural selection that would have been necessary for such predispositions to take hold.

Secondly, there is substantial variation in human culture, even where available technologies and resource endowments are similar, and such variation is consequential for economic performance. Third — and this for North is the new ground broken here — this variation reflects the consequences of different learning or acculturation, which results in different groups of people having different “mental models” of the world, particularly the world of human relationships.

Although I would probably choose somewhat different vocabulary from North, I’m with him on most of this. But for me, the frustrating feature of this book is that it does not really advance the discussion beyond this framing of the problem. Some of this is reflected in assertions that lack adequate substantiation. For example, a theme reiterated at several points is that “Problems posed by the transition of a belief system from one constructed to deal with the physical environment to one constructed to confront the complex problems of the human environment are at the core of the problems of economic development …” (pp. 44, see also p. 71). Are they? It’s not at all clear that the problems of navigating the human environment are fundamentally different from what they were two millennia ago or even earlier, one of the reasons students of politics and philosophy can still read with profit the writings of classical Greeks, or fifteenth-century Italians.

Another problematic area is the treatment of the cognitive sciences. North acknowledges lack of competence to choose among the various models of learning that have been set forth (p. 24), although he does seem to favor proponents of the neural networks or connectionist program. This approach attracted a great deal of excitement in the 1980s, but the enthusiasm for it, like that for the earlier AI (artificial intelligence) program, is now waning in many circles. If North is right about the importance of the formation of mental models in understanding economic change, we will have to be more definitive in making judgments about which seem to be the most promising lines of inquiry, and how specifically they can help us understand economic and political change.

North’s identification of the key issues that confront us is valuable, although some of the logic borders on the circular. For example, the “foundation of the study” (p. 36) seems to be the claim that societies that have successfully addressed big variations in their environment are likely to be able to successfully address big variations in their environment in the future, and therefore are likely to survive and prosper. Compared to earlier formulations there is novelty in identifying the mechanism for more flexible response in a population’s diversity of mental models of human interaction; this relates closely to the subsequent discussion of the benefits and costs of political conformity (p. 42) which is in turn linked to the role of political fragmentation in encouraging growth in the West that was prominently featured in North and Thomas (1973). But of course this is one of those statements that is true except when it is not, that is, when a previously diverse society becomes more ideologically conformist and less flexible. If we are to make progress, we are going to need to do better than simply offer ex post “understanding” of why such a change takes place.

Here is my most fundamental area of disagreement. North sees institutions “as an ongoing response to the … uncertainties that humans have confronted” (pp. 14-15). But institutions reflect more than this. They reflect the behavioral predispositions that make possible orderly interaction among humans, and some of these have little to do with uncertainty or strategies to reduce it. North’s framing of the problem comes from placing too much emphasis on the legacy of Herbert Simon’s work, particularly its emphasis on bounded rationality, as the most significant limitation to the rational choice approach. The Simon influence is reflected, for example in the statement that “If individuals have perfect perception, then there may not be any need for institutions even in the face of uncertainty” (p. 22)

Some of the most basic human predispositions, particularly those enabling orderly social interaction, have nothing to do with reducing uncertainty. Experimental evidence makes quite clear that some of us, some of the time, are prepared to cooperate in a one-shot prisoners’ dilemma, even though this represents the choice of a strictly dominated strategy, and even though the logic of choosing otherwise is completely independent of any uncertainty about what the counterparty will do. The willingness of substantial numbers of humans to violate the unambiguous predictions of game theory in both cooperating and in engaging in third party punishment underlies our ability to initiate and sustain social order.

It is true that we find throughout the book statements such as “Informal norms develop that blend the moral inference of genetic origin with the intentional aims of humans, which together provide the backbone of what we should mean by the term culture” (p. 42). But we also read that “If the highest rate of return is to piracy we can expect that the organizations will invest in skills and knowledge that make them better pirates” (p. 61). Well, not necessarily. If “informal norms … that blend the moral inference of genetic origin …” are strong enough, this won’t happen. The statement about piracy contributes no more to understanding an outcome than stating, as something so self evident that it requires no empirical validation, that if a player has a strictly dominant strategy she will play it. As the experimental evidence for PD games shows, this game theoretic conclusion may be quite unambiguous, but also, as an empirical matter, it is frequently wrong.

Here is another example: “the rash of entrepreneurial malfeasance in large U.S. corporations in 2001-02 has reflected the evolution of an institutional framework that has altered relative prices to provide incentives for such anti-social behavior” (p. 77). If the institutional framework is defined broadly enough so as to incorporate social norms and the mental models that undergird them, this cannot be wrong. But the statement gives us little insight into whether we should search for the explanation in some identifiable change in formal rules or whether this behavior reflected a broader cultural development.

Readers interested in North’s latest thinking about what sorts of issues we need to explore in understanding economic growth and development will find much in the book that is useful. Those looking to push out the frontiers of our scientific understanding will be disappointed. We face great challenges as well as opportunities in trying to make operational the types of explanations suggested by North’s roughly sketched out framework.

Alexander J. Field is the Michel and Mary Orradre Professor of Economics at Santa Clara University, and the author of Altruistically Inclined? The Behavioral Sciences, Evolutionary Theory, and the Origins of Reciprocity (University of Michigan Press, 2004, paperback).