True North

Douglass North, the under-appreciated Nobel Laureate

if the institutional framework rewards piracy then piratical organizations will come into existence; and if the institutional framework rewards productive activities then organizations – firms – will come into existence to engage in productive activities.

—Douglass North, Nobel Prize Lecture, 1993

Even if you major in economics in college, you are unlikely to encounter the name of Douglass North. That reflects the scandalous state of mainstream economics. If this essay does nothing else, I hope it leads you to read his Nobel Lecture.

In fact, North continued to do pathbreaking work. I also invite you to read my review of Violence and Social Orders, which he co-authored in 2009 with John Joseph Wallis and Barry R. Weingast.

North is under-appreciated by mainstream economists. So if you want to read mainstream economists make the point that political institutions cause differences in economic performance, you could attempt to slog through Why Nations Fail, by Daron Acemoglu and James Robinson, a book that was recently reviewed by an economist on Scott Alexander’s substack. The reviewer criticizes the authors for doing “narrative history,” which he says is not as good as their academic work, which used statistical methods. But the reviewer correctly points out that those statistical methods are faddish and unreliable. Personally, I will take narrative history over those methods any day.

The review does not mention Douglass North. It does mention Joel Mokyr, who is one of two prominent exponents (the other being Deirdre McCloskey) of an alternative causal force located in culture and psychology. That is, when a culture adopts a positive attitude toward innovation, it is rewarded with innovation and economic growth. While I am recommending reading, let me suggest Mokyr’s review of a book by McCloskey and Art Carden. Note that Mokyr finds McCloskey’s libertarianism excessive, and he ends up defending the institutionalist view.

Institutional/Cognitive Analysis of Political Economy

Let me try to sort this out. The big question is why some countries started to get rich a couple of centuries ago, why some developed later, and why some remain poor to this day.

There was a time when historians looked at materialist explanations. England had coal, for example. But we can think of many examples of resource-rich countries that developed slowly, and there are resource-poor countries that developed quickly.

Instead, North frames the problem and its solution this way:

Let me pose the issue that time presents us by a brief institutional/cognitive story of long-run economic/political change…

Incentives embodied in belief systems as expressed in institutions determine economic performance through time, and however we wish to define economic performance the historical record is clear. Throughout most of history and for most societies in the past and present, economic performance has been anything but satisfactory. Human beings have, by trial and error, learned how to make economies perform better; but not only has this learning taken ten millennia (since the first economic revolution) – it has still escaped the grasp of almost half of the world’s population. Moreover the radical improvement in economic performance, even when narrowly defined as material well-being, is a modern phenomenon of the last few centuries and confined until the last few decades to a small part of the world. Explaining the pace and direction of economic change throughout history presents a major puzzle.

He writes,

institutional/cognitive analysis should explain path dependence, one of the remarkable regularities of history. Why do economies once on a path of growth or stagnation tend to persist? …the difficulty of turning economies around is a function of the nature of political markets and, underlying that, the belief systems of the actors.

Iraq, China, and the natural state

I recall that shortly after the United States deposed Saddam Hussein in Iraq, a general made a plea to social scientists to help with the process of turning that country into a democracy. I wanted to scream “No!” As North wrote in his Nobel lecture,

Political institutions will be stable only if undergirded by organizations with a stake in their perpetuation.

…While economic growth can occur in the short run with autocratic regimes, long run economic growth entails the development of the rule of law.

…Successful political/economic systems have evolved flexible institutional structures that can survive the shocks and changes that are a part of successful evolution. But these systems have been a product of long gestation. We do not know how to create adaptive efficiency in the short run.

Fifteen years after the lecture, he along with Weingast and Wallis had fleshed out these ideas. What they call an open-access order could not possibly have been established in Iraq. Any attempt to do so was bound to bring chaos, which is what happened.

When there are several groups capable of engaging in violence in a country, the best that one can hope for is a limited-access order. That is, the warring groups form a coalition that shares the bounties of the country (oil, in the case of Iraq) and excludes everyone else. This sort of gangster economy is what North, Weingast and Wallis call the natural state. It is not conducive to open economic competition and innovation, but at least it is stable.

How does a country evolve from the natural state, in which political and economic power are confined to a few groups, to an open-access order, in which anyone can form an organization that can compete for political and economic power? The process is like a slow climb up a slippery slope. The ruling coalition first extends liberty to its members. After its own rights have been protected, it may tentatively and gradually extend rights to others. If this proceeds steadily, it may reach a point of a liberal democracy.

But consider China today. Two decades ago, the Chinese government appeared to be allowing broader participation in the business sector. More recently, that process has apparently stalled, with the Communist Party reverting to a natural state that does not permit those outside the ruling caste to form economic or political organizations.

One aspect of economic development that North does not emphasize is national average IQ. Garett Jones emphasizes this in Hive Mind.

Material conditions also matter. As Peter Zeihan points out, the ability of the United States to ship goods internally and externally made economic development easier. Africa’s lack of harbors and especially internal water transport pose a challenge for economic development.

Most of all, political institutions matter, as North pointed out and Acemoglu and Robinson reinforce. I believe that it is easier to have good political institutions in a small polity. Think Norway or Singapore, although having a small polity by no means guarantees good institutions (low national average IQ can negate any advantage a small polity might otherwise have).

The top ten countries by population, other than the United States, are India, China, Indonesia, Pakistan, Nigeria, Brazil, Bangladesh, Russia, Mexico, Ethiopia. Not one admirable government among the bunch. Large size is protective against invasion from the outside, but otherwise there is little to be said for it from an institutional quality perspective.

This essay is part of a series on human interdependence.

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