Monday, December 5, 2011

Knowledge and Limits

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.


But knowledge is sensitive to transaction costs, because the more you know about one speciality, the more you are reliant on others' abilities in other areas. Knowledge needs to be integrated.

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.

This is something I think about all the time - the stupendous limitless amount of knowledge, far far beyond the ability of anyone to comprehend. People take refuge in specialities, and we all rely on huge volumes of knowledge we barely are aware of, from avionics as an aircraft is on final approach to language skills in international trade and diplomacy, to all those mysterious tech manuals about "Sharepoint" or "CISCO certification" which take up an entire section in the average Barnes and Noble.

And integrating knowledge involves more than just a market and price system. 

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.

So growth has generally required effective impersonal mechanisms to mediate knowledge as well.  It gets harder and harder to integrate knowledge on an effective way - although tools like Google help.

In fact, there is a more general conclusion:

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.

But on another level it is a distilled insight about what really matters. it is a point of clarity in a dark sea of surging opinion.

Limits to our understanding and limits to change

North had opened the book with a declaration that economic rules are ultimately about human beliefs and intentions. But that does not mean that we have a blank slate to design new societies. 

Social engineering is not easy. We could have guessed that from the results, of course, from the Greek welfare state to Mao's Great Leap Forward. But this helps explain why there are many countries which change their political constitution with limited or even disastrous results.

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. 

And it is all the harder to get it right when we have little experience of the new conditions and challenges and situations we have to grapple with.  

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.

That is not good news when change is happening so quickly.

So in the end successful change depends on changing people's beliefs. 

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. 

It is an interesting combination of both left and right. It is very difficult to deliberately change society - it tends to evolve under a range of different selective pressures. But you can effect some change just by changing the terms of the debate.

The question I am left asking is - can beliefs, culture and therefore institutions and incentives change and evolve fast enough to keep up with technological change? Beliefs tend to change slowly.

The printing press and the cannon changed the world. Automation and AI can do the same thing - in a tenth of the time. Do we get disorder and breakdown, evolving in response to outdated beliefs, or do we get new incentives to make a new shift in the economic axis of the world?

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