RIP: Prof Douglass North

The blog was on a break which got longer than planned. There has been no blogging for a while and it is quite a sad post to start off with.

Prof Douglass North  passed away this week. No words can do justice to the contribution made by Prof North to institutional economics.  There is a collection of tributes on MR and another one at his Univ website.

I only have couple of things to add. I was once reading his interview where he said he learnt most of his economics after his PhD! Moreover, he mugged and cleared his written comprehensive exams (a set of exams in a Phd program one has to clear before writing the dissertation). But the people on his oral viva figured he knew very little about economics. They could not fail him as his written scores were really good! Sometimes inefficiency in the system does some good :-) In the same interview, he also explains how his first students did not take him seriously at all. He thought the students were smarter than him.

Knowing Hos Prof North shaped economics later on, one can hardly believe all this. As they say, if one stays committed to a cause(with dash of some luck), anything can happen in life.

Here is another tribute posted on eh.net:

Douglass C. North passed away at the age of 95 at his home in Benzonia, Michigan.  He was among the most important and influential economic historians and economists of the late 20th century.  He will be deeply missed by his family, friends, colleagues, and students. 

            Douglass Cecil North was born on Nov. 5, 1920, in Cambridge, Massachusetts, the youngest of three children. He attended the University of California-Berkeley, graduating in 1942.  He received his PhD from Berkeley in 1952.  He began teaching at the University of Washington Seattle in 1950, and in 1983 moved to Washington University in St. Louis, where he remained a professor for the rest of his career.  He was co-recipient of the 1993 Nobel Memorial Prize in Economic Sciences with Robert Fogel.

            He is survived by his wife Elisabeth Case and his three sons Douglass, Christopher, and Malcom.

            The following description of his intellectual accomplishments are taken from John Wallis “Persistence and Change: The Evolution of Douglass C. North,” in Institutions, Property Rights, and Economic Growth: The Legacy of Douglass North.” Edited by Sebastian Galiani and Itai Sened. Cambridge University Press, 2014.

            North long emphasized the importance of history and of neo-classical economics.  He criticizes both disciplines for their complacency about the adequacy of the current conceptual and methodological consensus on how history or economics should be done.  He always operated within a framework of individuals who act intentionally (neo-classical economics matters) and who perceive the world through cognitive lenses that are part inherited from their culture and part derived from their own experience (history matters).  Individual actions are governed by interests shaped by relative prices, endowments, and constraints (institutions) as well as by perceptions of how the world around us works (cognition and beliefs).   Social outcomes are the sum of individual actions, but the summation process is not a simple adding up, since interactions between individual decisions and beliefs critically influence the behavior of everyone.

            The evolution of North’s thinking continuously shaped his willingness to pursue the interesting questions he was unable to address in his last book or paper, not by the what was currently hot in the profession.  Testimony to the power of his insight is that the profession has followed him, for he certainly didn’t followed the profession. Nowhere is it easier to see this process than in his first book, The Economic Growth of the United States, 1790-1860.  The introduction, page vii, states his conceptual approach:

This study is based on the proposition that U. S. growth was the evolution of a market economy where the behavior or prices of goods, services, and productive factors was the major element in any explanation of economic change. Institutions and political policies have certainly been influential.  They have acted to accelerate or retard growth on many occasions in our past, primarily by affecting the behavior of the prices of goods, services, or productive factors either directly or indirectly.  But they have modified rather than replaced the underlying forces of a market economy.

It is hard to imagine a conceptual statement that more inaccurately predicts the path that North’s research eventually followed.

            Economic Growth was one of the first examples of quantitative economic history, or cliometrics, North’s first major contribution to economics and economic history.  The book presented a very neo-classical theory of economic development that emphasized the importance of geographic specialization and division of labor, which led him to investigate the sources of falling transportation costs over the nineteenth century.  His 1958 paper in the Journal of Economic History laid out a technology based neo-classical framework for thinking about declining freight rates, but ten years later, in his 1968 Journal of Political Economy paper, Northconcluded that: “The conclusion one draws is that the decline of piracy and privateering and the development of markets and international trade shared honors as primary factors in the growth of shipping efficiency over this two-and-a- half-century period.” (p. 967).  Essentially, the costs of shipping were falling because costs other than the costs of operating ships were falling.  Those cost reductions were the result of institutional change.  The paper marks North’s turn toward both transaction costs and institutions as important elements of economic change over time.

            The turn towards transaction costs and institutions did not mean a turn away from neo-classical economics, however.  The assumption of zero transaction costs and unchanging institutions could be relaxed within the context of neo-classical theory, as North argued in 1971: “What we need is a body of theory which encompasses the traditional models of the economist and both widens its scope and allows us to include an explanation of the formation, mutation and decay of organizational forms within which man cooperates or competes.”  North was moving toward a neo-classical theory of institutions in which the form of institutions, or organizations, was itself determined by traditional neo-classical rationality and constraints:

Let us begin on a positive note. Briefly stated, the model specifies the process by which an action group (an individual or group) perceive that some new form of organization (institutional arrangement) will yield a stream of benefits which makes it profitable to undergo the costs of innovating this new organizational form. These new arrangements have typically been profitable to realize potential economies of scale, reduce information costs, spread risk, and internalize externalities. These institutional arrangements account for a vast array of the “economic institutions” with which economic historians have traditionally been concerned. However, the formation (and mutation and decay) of these organizational forms can now be an integral part of the economic analysis rather than a descriptive addition to the analysis. Moreover, since a great many were realizable without substantial redistribution of income, their formation is at least in principle predictable from the model. Perhaps even more significant than the ability to integrate economic analyses and institutional formation is the implication of this theoretical model for the study of productivity increase. Economic historians have focused on technological change as the source of growth but the development of institutional arrangements from the above mentioned sources are a major historical source of the improvement in the efficiency of product and factor markets. The development of more efficient economic organization is surely as important a part of the growth of the Western World as is the development of technology, and it is time it received equal attention. The few cases of which I am aware that have attempted to measure productivity change attributable to improving economic organization certainly support this contention. (1971, pp. 119-120)

            The idea that neo-classical theory could be used to explain why institutions functioned as they did was a fundamental breakthrough and North’s second major conceptual contribution.  The idea was implemented in a series of papers with Lance Davis and with Robert Paul Thomas, that led to two more books: Institutional Change and American Economic Growth, published in 1971 with Davis and The Rise of the Western World published in 1973 with Thomas.  The heart of the argument in both books is that we can explain changes in the organization of human interaction (institutions) on the basis of the rational interests of individuals attempting to structure the world around them in ways that maximize net benefits.  The classic application of the technique is North and Thomas’s explanation of how the rising price of labor in 14th century Europe as a result of the Black Death, led to the institution of wage labor in western Europe and a return to the institution of serfdom and slavery in eastern Europe.  The same relative price shock led to two different, but both rational, institutional changes.

            Two lines of thinking emerged from the idea of neo-classical institutions, and they were not entirely consistent with one another.  In one line, institutional change occurs because of short-run variations in relative prices that create, at some point in time, the incentives to restructure human organizations.  For some reason these changes persist.  This led North to investigate both path dependence and transaction costs.  Transaction costs play a key role, because they are both a reason to change institutions to reduce (or increase) transaction costs and because transaction costs subsequently can make it difficult to change institutions and so contribute to institutional persistence.

            The other line of thinking was a growing dissatisfaction with neo-classical economics altogether as a way to understand the process of economic growth specifically, and more broadly to understand the process of economic change over time.   His third significant breakthrough was the realization that neo-classical theory was not just inadequate, but unable to explain long term economic and institutional change in any society, growing or not.

            He directed his first clear criticism at economic historians. While acknowledging the important contribution that economic theory and quantitative techniques made to advancing our understanding of historical processes, nonetheless:

From my quite subjective perspective, the new economic history has made a significant contribution to revitalizing the field and advancing the frontiers of knowledge. Yet I think it stops short — far short – of what we should be accomplishing in the field. Our objective surely remains that of shedding light on man’s economic past, conceived in the broadest sense of those words; and I submit to you that the new economic history as it has developed has imposed strictures on enquiry that narrowly limit its horizons-and that some of my former revolutionary compatriots show distressing signs of complacency with the new orthodoxy.  (1974, p. 1)

            His criticism of neo-classical theory in economic history, development, and growth would culminate in Structure and Change in Economic History, 1981, what many (including myself) believe is North’s best book.  The introduction and a second chapter extend the argument that we must have more than a history of markets to understand economic change.  The third chapter titled “A Neoclassical Theory of the State,” lays out a logical neo-classical argument for why, in the presence of transactions costs, political systems do not inevitably evolve institutions that promote economic growth.  Indeed, as long-term economic history suggests, the tendency is for political systems to evolve that do not support growth. Chapters four and five argue that we need a theory of organizations as well as a theory of beliefs and ideology if we are to understand long run change, particularly long run change that does not inevitably produce growth and development.

            The contradiction is clear in Structure and Change.  On the one hand, there is a strong argument that neo-classical economics is incapable of delivering the full range of explanations necessary to understand economic change, particularly ideologies and beliefs.  On the other hand, there is a strong argument that rational individual behavior is consistent with institutional choices that retard, rather than promote, economic growth.  Is the question to be neo-classical or not be neo-classical?

            The real question the book is trying to grapple with is: persistence or change?  Going back to Rise of the Western World, institutions change when there are gains from doing so, but then  persist because of the high transaction cost of changing them.  In Structure and Change, beliefs and ideologies persist.  Because beliefs (and norms and culture) are based on the cumulative experience of society passed down through culture and formed through repeated interaction of many people through norms of behavior, beliefs do not change quickly and it is extremely difficult to for social actors to manipulate beliefs in current time.  As a result, beliefs are always a function of what happened in the past and can impede change in the present for good or ill.  It is the persistence of beliefs and institutions from the past (culture) that explain why changes in the present often produce results that impede rather than promoting growth and development.  The importance of beliefs in North’s framework plays a major role in Institutions, Institutional Change, and Economic Performance (1990) and is the central focus ofUnderstanding the Process of Economic Change (2005).

            The Structure and Change framework includes two different time patterns of institutional change.  One is episodic and discontinuous, like the move toward wage payments after the Black Death in western Europe.  The other is continuous and marginal. Changes in beliefs and ideologies, in norms, and in informal and formal rules occur constantly and, while changes sometimes persist, they need not.  Neither continuous or episodic institutional change is necessarily persistent.

            Fleshing out these ideas in the 1990s produced a classic example of change during a crisis that persists: “Constitutions and Commitment” with Barry Weingast (1989).  The paper’s emphasis on institutional mechanisms explains why particular institutions are self-enforcing and persist over time.  At the same time North was writing Institutions, Institutional Change, and Economic Performance.  Persistence plays a large role in Institutions, which regularly emphasizes that the function of an institution is to provide stability and predictability to human behavior.  The big contribution of the book, however, is the definition of institutions that Northcalls the sports analogy.  Institutions are the rules of the game and the means of enforcement, and organizations are the teams that play the game.  The definition motivates three behavioral choices that organizations can make.  1) maximize under the rules; 2) devote resources to changing the rules; and/or 3) cheat.  The alternatives are not mutually exclusive, and they comprise a framework for understanding the dynamics of institutional change.

            North’s fourth major contribution was to separate institutions and organizations.  Since his earliest books, North always included a discussion of organizations as important, but organizations were treated as manifestations of institutions.  Organizations usually disappeared from the conceptual framework, which was always neo-classical in its focus on individuals.  By defining institutions as the rules of the game and means of enforcement and then separating the rules from the organizations that actually play the game, the possibility of a dynamic relationship between the interests and incentives facing the organizations and the structure of the rules became possible.  The descriptive concept that comes out of the dynamics is ‘adaptive efficiency.’  In some societies, the interaction of institutions and organizations produces a series of institutional changes that get incrementally better, rather than a sequence that is sometimes good and sometimes bad for economic performance.  This is North’s fourth fundamental contribution.

            Rather than resolving (or integrating) the tension between the long and short term forces  leading to institutional change, Institutions exacerbated it.  The rules of the game included formal rules, informal rules, and norms of behavior.  By stressing the function of institutions as providing stability and predictability, and emphasizing the importance of beliefs and norms, the book effectively claimed that the persistence of institutions was not a matter of real-time economic and political forces, but an outcome of the natural limits to human capacities for cognition and culture.  North pressed farther down this road with his 2005 book, Understanding the Process of Economic Change.  The interaction between organizations and institutions was a central point in his last book with John Wallis and Barry Weingast, Violence and Social Orders in 2009.

One Response to “RIP: Prof Douglass North”

  1. Mitali Naik Says:

    Nice article. Summarizes Prof. North’s work really well.

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