I'm discussing Douglass North's book Understanding Economic Change. We've looked at uncertainty, institutions and incentives, the dynamics of change, and political transaction costs.
But of course at the heart of economic change is knowledge.
It is the growth of knowledge about how to get things done that has been the central phenomenon of economic evolution. The greater the specialization and division of labor in a society the more dispersed is the knowledge in a society and the more resources must be devoted to integrating that dispersed knowledge.
The integration of this specialized knowledge with low costs of transacting requires more than an effective price system. Institutions and organizations were necessary to supplement the price system where externalities, information asymmetries, and free rider problems had to be overcome. The increasingly dispersed knowledge of modern societies requires a complex structure of institutions and organizations to integrate and apply that knowledge. The implication is fundamental to this study: The growth of knowledge is dependent on complementary institutions which will facilitate and encourage such growth and there is nothing automatic about such development.
Growth has been generated when the economy has provided institutional incentives to undertake productivity-raising activities such as the Dutch undertook. Decline has resulted from disincentives to engage in productive activity as a consequence of centralized political control of the economy and monopoly privileges. The failures vastly exceed the successes.
On one level, that is obvious, as most major ideas in the social sciences are.
Limits to our understanding and limits to change
A mixture of formal institutions, informal institutions, and their enforcement characteristics defines institutional performance; and while the formal institutions may be altered by fiat, the informal institutions are not amenable to deliberate short-run change and the enforcement characteristics are only very imperfectly subject to deliberate control. The reason should be clear from the foregoing chapters. We are continually altering our environment in new ways (and there are also non-manmade alterations), and there is no guarantee that we will understand correctly the changes in the environment, develop the appropriate institutions, and implement policies to solve the new problems we will face.
We tend to get it wrong when the accumulated experiences and beliefs derived from the past do not provide a correct guide to future decision making.
Understanding the cultural heritage of a society is a necessary condition for making “doable” change. We must have not only a clear understanding of the belief structure underlying the existing institutions but also margins at which the belief system may be amenable to changes that will make possible the implementation of more productive institutions.