Douglass C. North's New Institutionalism

By Dugger, William M. | Journal of Economic Issues, June 1995 | Go to article overview

Douglass C. North's New Institutionalism


Dugger, William M., Journal of Economic Issues


Along with Oliver E. Williamson and other new institutionalists, Douglass C. North changed some of the neoclassical assumptions about economic rationality and emphasized the importance of transaction cost minimization. North and his colleagues take a game-theoretic approach to work out the implications of their altered assumptions. They develop new models but not new theory. While Williamson has focused on the antitrust implications of transaction cost minimization, North concentrated on the implications of transaction costs for the historical role of the state. Unlike Williamson, who credits John R. Commons with first emphasizing economic transactions [Dugger 19831, North ignores the original institutionalist literature; be has had to (re)discover on his own that institutions and historical processes matter in economics. In doing so, North has tested the narrow confines of neoclassicism--Williamson has not.

Institutions Matter

In his Nobel Prize lecture, North states: "When it is costly to transact then institutions matter. And it is costly to transact" [North 1993, 4]. With the Nobel Prize to his credit, he has made it hard for neoclassicists to ignore institutions. The same is now true for his colleagues in cliometrics. North's prize makes it hard for them to ignore history. North started out as a cliometrician, eager to clear out the alleged muddle of economic history by applying the analytical rigor of neoclassical theory and statistical technique to the testing of hypotheses. However, he (re)discovered that historical processes matter and be has changed his mind about history. He has found it to be more than a cliometrician's test tube. North states:

History matters. It matters not just because we can learn from the

past, but because the present and future are connected to the past

by the continuity of a society's institutions. Today's and tomorrow's

choices are shaped by the past. And the past can only be made intelligible

as a story of institutional evolution [North 1990, vii].

North's appreciation of history and of institutions is unusual and commendable for a neoclassical economist. So too is the care be takes in defining an institution:

Institutions are the humanly devised constraints that structure

political, economic and social interaction. They consist of both informal

constraints (sanctions, taboos, customs, traditions, and codes of

conduct), and formal rules (constitutions, laws, property rights.

Throughout history, institutions have been devised by human

beings to create order and reduce uncertainty in exchange.

Together with the standard constraints of economics they define the

choice set and therefore determine transaction and production costs

and hence the profitability and feasibility of engaging in economic

activity. They evolve incrementally, connecting the past with the

present and the future.... Institutions provide the incentive structure

of an economy; as that structure evolves, it shapes the direction

of economic change towards growth, stagnation, or decline

[North 1991, 97; see also North 1993, 4].

North's definition narrowly emphasizes institutions as constraints and largely confines his analysis to incremental change. But, he also recognizes that institutional change is not guided by an invisible hand into some "normal" and beneficent path. He breaks out of the narrow confines of neoclassicism with this recognition. But his recognition does not lead him to an alternative theory. Instead, be builds a neoclassical theory of institutional change in which the only thing missing is the invisible hand.

Neoclassical Theory of Institutional Change

The Causes of Change

North's theory of institutional change is a neoclassical theory because it uses changes in relative prices and the entrepreneurial responses to those changes as the causal forces for explaining changes in institutions. …

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