Essay: Douglass Cecil North

Douglass Cecil North was born on November 5, 1920 in Cambridge, Massachusetts (Hirsch 209). He spent his youth living in various locations across the United States and Europe, primarily due to his father’s position as a manager at the Metropolitan Life Insurance Company (Hirsch 209). Over the years, the North family resided in Connecticut, California, Canada, and Switzerland (Hirsch 210). While North describes his family as being nonintellectual, his mother heavily emphasized the importance of a well-rounded education, which led them to Lausanne, Switzerland where North attended school from 1929 to 1930 (Hirsch 210). By 1933, the North family had returned to the United States, where North completed his high school education at the Choate School in Wallingford, Connecticut before going on to college (Hirsch 210).
Despite being accepted to Harvard University, North decided to attend the University of California in Berkeley in order to be closer to his family, then living in San Francisco (Hirsch 210). During his time at Berkeley, North found himself to be heavily influenced by Marxism based on its ability to provide answers to questions that failed to be answered by pre-Keynesian economics, such as the source of the Great Depression (Hirsch 209). This influence became evident in much of North’s later work on the development of economic theory. North graduated from University of California in Berkeley in May 1942, earning three undergraduate degrees in political science, philosophy, and economics (Hirsch 210).
Following completion of his undergraduate studies, North served as a U.S. Merchant Marine from 1942 until 1946 to avoid participating in World War II, which he adamantly opposed (Hirsch 211). While serving as a navigator, North spent a significant amount of time reading various works of economic literature, which enabled further development of his interest in the field (Hirsch 211). Eventually, North found himself torn between pursuing a career in economics or a career involving his other passion, photography (Hirsch 211). In hopes of gaining further insight into the field of photography, North spent time studying under renowned photographer Dorothea Lange (Hirsch 211). Lange’s husband happened to work in the economics department at the University of California and ultimately convinced North to pursue a career in economics (Hirsch 211).
Having earned a ‘C’ average in his undergraduate studies, North enrolled in the graduate program at University of California in Berkeley, failing to get accepted elsewhere (Hirsch 211). North’s primary focus while at graduate school was determining what made economies succeed or fail, which he anticipated being able to answer through the study of economic history (Hirsch 211). North earned his PhD in economics in May 1952 with his dissertation on the history of life insurance in the United States leading him to the east coast for a Social Science Research Council Fellowship (Hirsch 211). While on the east coast, North audited sociology seminars by Robert Merton at Columbia University and became an active member of the Entrepreneurial Center of Arthur Cole at Harvard (Hirsch 212). It was at the Entrepreneurial Center, that North met Joseph Schumpeter, who he cites as having a significant influence on his views about economic development (Hirsch 212).
North started his professional career in economics as an assistant professor at the University of Washington in Seattle, Washington (Hirsch 211). It was during his time at the University of Washington that North says he gained a full understanding of economic theory while playing chess with theorist Dan Gordon, which he attributes as being the most important skill he had ever developed (Hirsch 211).
In 1955, North publishes his first article ‘Location Theory and Regional Economic Growth’ in which he develops an analytical framework to evaluate regional economic growth or more specifically, ‘a staple theory on economic growth’ (Hirsch 212). This article is typical of North’s early work in that it primarily focuses on American economic history. In the article, North explains why the theory of regional economic growth fails to accurately explain the development of regions in America, as well as any region in which development occurred within the framework of capitalist institutions (243). North presents
the five stages of regional development proposed by Hoover and Fisher, which consist of 1) region starts off as a self-sufficient economy in which there is little investment or trade, primarily agricultural, 2) improvements in transportation lead to some trade and local specialization, 3) increased interregional trade leads to further development of agriculture, 4) increased population and diminishing returns in agriculture lead to a region being forced to industrialize (meaning, the introduction of secondary industries like mining and manufacturing, and a shift from focus on agricultural products to that of mineral and energy), and finally 5) a region specializes in industries for export to less advanced regions ( 244).
According to North, the issue with these stages lies in the fact that they fail to accurately describe the development of regions in America or provide any insight into the causes of growth or change, while also presenting a ‘misleading’ emphasis on the need for industrialization (245). The stages of development begin with a society that is based solely on subsistence, while the settlement and expansion in America began as a capitalist venture with intent to obtain goods for trade within the world markets (North 245). North suggests that Hoover and Fisher likely based these stages on Europe’s development of a market-oriented economy out of a manorial system, which differs greatly from the development of the market in America (245).
North cites the economic history of the Pacific Northwest as an example, in which the first wheat shipment went from Portland to Liverpool in 1868, indicating vast markets from the very beginning (246). The argument against a need for industrialization for regional growth is that a great deal of secondary industry will develop automatically either because of locational advantages of materials-oriented industry or as a passive reflection of growing income in the region as a result of successful exporting (North 254).
North declares the concept of industrialization to be too ambiguous to be useful without further clarification and argues that it is not necessary for regional growth as suggested by Hoover and fisher (254). Due to the likelihood of exporting resulting in the emergence of a significant amount of secondary industry due to locational advantage or growing regional income, North believes that industrialization is not a prerequisite for growth (254). If exports are a primary source of economic growth, then it is likely that a change in demand, excessive use of natural resources, increased land or labor costs, and technological changes may adversely affect economic growth, while transportation improvements may have a positive effect (North 255). Growth may also be impacted by state and federal governments, as well as wartime production industries (North 255). Eventually, as regions mature they will become increasingly similar to one another, as exports become more varied over time (North 255).
In summary, North declares that the first stage of subsistence is relatively unimportant, the second stage based on the gradual nature of market growth to be irrelevant, and the need for industrialization to be unfounded (256). Finally, the last stage, defined as a mature regional economy that exports capital, skills, and specialized services to less developed regions is deemed to be inaccurate for many regions (North 257). North concludes his first article by reiterating his intent on developing a new and improved theory of regional economic growth, based on reexamination of location theory and the theory of regional economic growth in relation to historical development in America (256).
North went on to become a research associate at the National Bureau of Economic Research (NBER) from 1956 until 1957, after meeting Solomon Fabricant at an Economic History Association (EHA) meeting (135). Based on his research while at the NBER, North went on to publish his first book, The Economic Growth of the United States, 1790-1860 in 1961, considered by many to be a founding work of literature for what would soon become known as ‘Cliometrics’ and new economic history (137). Focused on the role of exports and regional specialization in American economic growth, North makes significant use of data in supporting his various assertions, such as the relationship between transportation prices and interregional trade flows (137). North discusses empirical work which led to the major quantitative study of the balance of payments and the study of American economic history, later providing an analysis of how markets work within the context of an export staple model of growth (Hirsch 213).
The 1960s is characterized by the significant effort by young economic historians to transition the field of economics into an analytical, quantitative discipline, eventually leading to a new form of economics (Hirsch 213). In 1957, the NBER and EHA held the first quantitative program on growth of the U.S. economy in Williamstown, MA, which was determined to be the start of the new economics (Hirsch 213). Two of North’s former students, Hughes and Davis, played an influential role in founding this new form of economic history, calling for development and application of economic theory and quantitative methods to economic history (Hirsch 213). This new economics eventually came to be referred to as ‘Cliometrics’ (Hirsch 213). In collaboration with Morris D. Morris, North established a successful graduate program at the University of Washington, based solely on this new economics (Hirsch 213).
North discusses his stance on the field of economics in his article ‘The State of Economic History,’ published in 1965. The main point of the article is said to be the acknowledgement of the overall poor quality of economic history and the failure of new economic history to provide sufficient improvements (86). According to North, there is a need for economic history to be held to the same standards set forth by the scientific method, as is the case in other areas within the field of economics (86). The four primary deficiencies plaguing economic history include ‘1) vast areas of economic history [that] have not been assessed by use of economic theory and statistics, 2) many writings in economic history [that are] full of statements which have economic implications and imply causal relationships that are not supported by the research or run counter to basic economics, 3) writings often [presented with] various quotations and misused statistics as evidence, and 4) [many] broad welfare conclusions that are unwarranted’ (North 87).
Amongst the examples North cites as poor economic history are the Industrial Revolution, the Colonial period, and the Revolutionary War (88). Despite the duration of the Colonial period, North states that ‘there have been no studies of the performance of the colonial economy,’ despite potential cause for analysis stemming from ‘the relationship between the money supply, price levels, specie flows, and the balance of payments’ (88). North then goes on to say that economic history overemphasized the role of technological change in the emergence of the Industrial Revolution, failing to fully recognize the potential impact improved economic organization may have had (88). North is specifically referring to the period between 1500 and 1830, during which the Western world experienced significant improvements in factor and product markets, efficiency of resource allocation, and economies of scale, all of which could have played a role in later economic growth (88). North describes the period following the end of the Revolutionary War as being one of the most interesting periods in economic history (88). It was at this point that America needed to establish its political system and the ground rules for the economy, having to consider factors such as ‘problems of tax incidence, government participation in the economy, federal-state economic relationships, and monetary policy’ (North 88). Yet, economic history has yet to reach a consensus on economic performance during this period; failing to address the influence economic performance, economic issues, and ‘the underlying philosophical bent of the participants’ may have had during this period (North 88). Finally, North cites extreme negligence in analyzing the effects of the disposition of public land during the 19th century, while also attributing much of the economic growth during that time to government investments without having any legitimate supporting evidence (89). North concludes the article by suggesting that the new economic history fails to make any meaningful improvements based on its use of partial-equilibrium analysis for problems that have broad general-equilibrium implications (90).
Between 1966 and 1967, North decided to switch his focus from American economic history to European economic history, based on the belief that neoclassical economics was insufficient at explaining social change beyond medieval times (Hirsch 213). North began to study institutions, attempting to determine how and why they formed, which continued to be his point of focus over the entire duration of the 1970s (Hirsch 214).
As North increased his focus on institutions and the evolution of markets, he attempted to identify exactly where neoclassical economic theory fell short in explaining the evolution of markets. He found that neoclassical theory focused on the operation of markets with the assumption that underlying conditions were met, which failed to explain how markets evolved and often failed when applied to real world settings, in which these underlying assumptions were not always met (Hirsch 213). It became clear to North, that what was needed to explain the evolution of economies over time was a dynamic theory, whereas neoclassical theory was static (Hirsch 214). While Thorstein Veblen and John Commons provided some relevant insight to the problem, North explained the need for a theoretical framework, which neither had provided (Hirsch 214). Marxism was another considered approach, presenting valid questions and a solid explanation for long-run change (Hirsch 214). The problem with Marxism was the model it presented, which was prone to too many flaws, including the use of social class as a unit of analysis and failure to account for population changes (Hirsch 214). Ultimately, North determined that he would attempt to combine the strengths of neoclassical theory (i.e., a focus on scarcity and competition as being key to economics, use of the individual as a unit of analysis, and the power of economic reasoning), in unison with the insights provided by Veblen, Commons, and Marxism in order to create a new institutional economics (Hirsch 214).
North’s first attempt at addressing the limits of neoclassical economics and the role of institutions was in Institutional Change and American Economic Growth with Lance E. Davis, published in 1971. The limit of neoclassical economics was based on the fact that property rights, institutions, and rules of the economic game were assumed to be exist, which failed to reflect reality (Davis, North 7). Davis and North explained that change in institutional and economic organization was often needed to capture the gains from trade (7). Based on this, they provided a new interpretation of American economic growth, based on consideration of how economic agents pursued profit opportunity by changing the rules, in which case growth was the result of institutional evolution and not just capital accumulation as suggested by neoclassical theory (Davis, North 9). Evolution of capital markets, a rise of incorporation laws, the interaction between public law and manufacturing, public support for education, and institutional change in service industries are all considered to be a part of the economic growth process (Davis, North 9). Neoclassical economics fails to explain institutional evolution, as this evolution lies beyond the scope of the market, rather it involves how the market is defined and why the market is the way it is (Davis, North 14). The tools provided by neoclassical economics fail to enable one to understand how and why institutional arrangements occur (Davis, North 19). In order to truly understand economic growth, one must have an understanding of neoclassical factors and the evolution of politics and law that enable economic growth (Davis, North 49).
North published his next work, The Rise of the Western World: A New Economic History in 1973, in which he evaluates how and why the countries of the west have been able to sustain continued economic growth and increased living standards. Building off of the theory of institutional arrangements developed with Davis, North and Thomas explain the wealth of the West as being the result of efficient organization (12). While traditional theories of growth focused on capital accumulation, technology, and economies of scale as key determinants for economic growth, North and Davis suggest that these are amongst many other determinants of economic growth (16). In reality, economic growth can be attributed to a societies’ ability to create incentive for efficient development and implementation of institutional organization (North, Thomas 31). Trouble lies in the fact that institutional arrangements are not always efficient due to societal problems such as freeriding and transaction costs, as well as a tendency for institutional change to be a tedious and difficult process (North, Thomas 31).
Institutional change was evident in Western Europe where serfdom was prevalent from 900 to 1800 (North, Thomas 33). According to North, the prominence of serfdom was initially an efficient way to organize society; however this began to change over time in response to population and technological changes, which in turn altered relative prices (33). As a result of population growth, land became increasingly scarce and the relationship between serfs and lords began to change (33). The black plague also proved to be a critical factor in altering society within Europe, as a labor shortage eventually led to more favorable rights and obligations for serfs, enabling many to leave serfdom entirely (North 34).
History has proven that institutional change has not been kind to all, as was the case in Spain and France (34). While England witnessed an economic rise resulting from prior development of an institutional framework and political system, as well as securing private property rights and individualism, Spain and France failed to adopt an efficient framework, resulting in economic decline (35). North emphasizes that the development of growth is a path-dependent process that can lead to economic success should the political system adopt growth promoting institutions, or alternatively lead to economic failure in the event that growth promoting institutions are not adopted (35). Based on this, it is evident that an efficient political system is a key determinant in economic growth.
By 1974, North had once again found himself analyzing economic growth in America as discussed in his article Growth and Welfare in the American Past. In the article, North considers the key determinants of the economy’s growth rate, as well as the overall wellbeing of various sectors within society (2). To talk ‘meaningfully’ about growth and welfare, North states that it is necessary to use economic theory and statistics in doing so (2).
North defines economic growth as increased efficiency, that is, an increase in the production output per person, which he attributes to changes in technology, investment in human capital, and the efficiency of economic organization (6). Railroads were a prime example of the determinants of economic growth being put to work, becoming the first billion dollar industry over the course of the 19th century (108). North cites the railroads with playing a ‘revolutionary role in lowering transportation costs,’ while also helping to pioneer the development of corporate organization within the United States, leaving a lasting effect on efficiency levels (108).
North’s primary focus during the majority of the 1980s was the development of a political economic framework to explore long-run institutional change. In 1981, North published Structure and Change in Economic History, in which he abandons the idea that institutions are efficient and pursues an explanation for the development and persistence of inefficient rules (8). While North initially viewed institutions as rules for human interactions, this failed to explain how the choice of institutions were made, indicating the need for a theory of state and a theory of ideology (4). Performance was defined as the growth rate of output and its distribution within society, while the structure consisted of the determinants of performance, including political and economic institutions, technology, demography, and ideology (North 5). North explains the role of the state as being the provider of basic services, the rules underlying the economic game, and political institutions, with incentive to provide protection and justice in exchange for revenue in the form of taxes (6). This relationship between the state and its constituents was negotiated over time and is clearly defined within the current constitution (North 7). In this system, the ruler or state would be constrained by the risk of being replaced upon failure to act in the interest of constituents (North 7). In some cases, North says, there may be conflict in the event that the optimal set of rules for state revenue differs from those optimal for social output (7). Based on this, North declared a need for a complementary theory of ideology to assist in providing the moral system that would be necessary to support formal rules (8). In the second half of the book, North points to France, Spain, the Netherlands, and England, as prime examples of how the strengthening or weakening of property rights could result in the growth or stagnation of an economy (10). Countries in which property rights are well defined and well protected had a tendency to have more efficient economic organization (North 11).
With the recipe for economic growth seemingly well known amongst economists, one may be perplexed as to why all nations do not mimic the features that characterize successful economies. In his 1991 book Institutions, Institutional Change, and Economic Performance, North takes a second look at the rationality assumption and cites two problems, with the first problem being the human’s interpretation of the world around them and the second being the difficult associated with sorting the importance of various facts (5). Also discussed by North in Economic Performance through Time, is the perspective of neoclassical theory, which would imply that political leaders simply alter the rules to adjust the direction of failed economies, however is a vast oversimplification (7). North attributes the difficulty of making changes to economies to the basic nature and function of political markets and the underlying belief systems of the actors within those markets (7). History provides many examples of failed attempts at correcting economies, with one being the dramatic decline of Spain, which entailed a plunge from the glory days of the Hapsburg Empire during the 16th century to complete economic turmoil under the rule of Francisco Franco during the 20th century (North 12). During his rule, Franco was known for his endless self-appraisals and proposal of bizarre solutions in response to Spain’s economic troubles (North 12). North concludes that competition amongst institutions is unlikely to yield efficient results, due to the high transaction costs associated with the political system in which formal institutions are made (15). It is within this political system that various interest groups clash based on self-interests and varying underlying belief systems (15).
Despite the complexity of institutions, North suggests that they are a vital component of any developed society, as order and efficiency become increasingly difficult to sustain as societies continue to growth. In his article, ‘Institutions,’ published in 1991, North defines institutions as being ‘humanly devised constraints that structure political, economic, and social interaction’ (97). Two different types of constraints are identified, with the first being informal constraints, like taboos, customs, traditions, and codes of conduct and the second being formal constraints such as constitutions, laws, and property rights, with each one serving their own purpose within a much larger framework (97). Throughout history, institutions were created and used to establish order amongst societies and to reduce uncertainties in exchange (North 97). In combination with the constraints of economics, institutions determine transaction and production costs, which then determines the profitability and feasibility of engaging in exchange and other forms of economic activity (North 97). Because of their complex nature, institutions evolve incrementally, ‘connecting the past with the present and the future’ and assist in the establishment of an incentive structure within an economy (North 97). Over time, this incentive structure evolves and gradually shapes the direction of economic change towards growth, stagnation, or decline (North 97).
This need for constraints on human interaction is explained further by game theory. According to game theory, wealth-maximizing individuals will usually find it worthwhile to cooperate with other players when the play is repeated, when they possess complete information about the other player’s past performance, and when there are a small number of players (North 98). Cooperation is therefore difficult to sustain when these conditions are not in place, which is where the role of constraints comes into play. However, regardless of everyone’s objectives, it takes substantial resources to define and enforce exchange agreements, which in turn makes transactions costly (North 98). In the context of individual wealth-maximizing behavior and asymmetric information, transaction costs are a critical determinant of economic performance, as exchange will cease to exist should costs become too high (North 98). It is institutions and the effectiveness of enforcing these institutions that determines the cost of transacting (North 98). Effective institutions increase the benefits of cooperation or increase the cost of defection (North 98). In transaction cost terms, institutions reduce transaction and production costs per exchange so that the potential gains from trade may be realized (North 98). Ultimately, the concept of transaction costs can be applied to both economic and political institutions (North 98).
Throughout economic history, the central issue plaguing economic development has been the understanding of how political and economic institutions evolve to create an economic environment that is conducive to increased productivity (North 98). North breaks down economic development into multiple stages, starting with the earliest stage of an economy in which local exchange occurs within a village or hunter and gathering society, with trade gradually expanding beyond the boundaries of the village (99). Initially, trade expands from the village into the immediate surrounding areas, before expanding further out into the rest of the world via accessible transportation routes (North 99). Each stage consists of increased specialization and division of labor, as well as continuous improvements in productive technology (North 99). Within the initial stage of local exchange, there is a dense social network of informal constraints and transaction costs are low (North 99). Within this early stage of development, people share an understanding of one another and the threat of violence is sufficient in securing order within society (North 99). However, as trade expands there is an increase in the risk of conflict and transaction costs, as the size of the market grows and more resources are required for measurement and enforcement (North 99). Prior to the governance of states, it was religion that imposed codes of conduct upon early economic players; though the effectiveness of these informal constraints varied widely in terms of reducing transaction costs (North 99). With continued expansion, the development of long-distance trade demands substantial specialization, the emergence of economies of scale, in addition to geographic and occupational specialization (North 100). The two distinct transaction costs that arise out of this transition include a ‘classical problem of agency’ in which use of kin for long-distance trades and the negotiation and enforcement of contracts was no longer a viable option, as the process became increasingly difficult when taking place between two distance areas (North 100). In response to the early challenges associated with the enforcement of contracts, it became common for goods to be accompanied by armed forces (North 100). Other developments that arose to ease the burden of long-distance trade, included the ‘development of standardized weights and measures, units of account, a medium of exchange, notaries, consuls, merchant law courts, and enclaves for foreign merchants by local princes in exchange for revenue’ which all contributed to reducing information costs while also providing increased incentive for contract fulfillment (North 100). Eventually, it became apparent that super specialized societies would need effective, impersonal contract enforcement once personal ties, voluntary constraints, and ostracism were no longer sufficient upon the arrival of more complex and impersonal trade (North 100).
North continued his analysis of economic institutions into the 1990s, focusing his attention on market inefficiencies and human rationality (Hirsch 217). The fundamental issues that North believes must be addressed within modern economics include increased understanding of how people make choices, determining the conditions in which the rationality postulate is useful, as well as an understanding of how individuals make choices under conditions of uncertainty and ambiguity (Hirsch 220). Over the course of the 1990s, North worked to develop a more general economic model in an attempt to explain why political markets proved to be less efficient than economic markets (23). He defined two key factors of consideration within the model, the first being mental models, which are the internal representations that individual cognitive systems create to interpret the environment and institutions, which are external mechanisms developed by individuals to create structure and order within the environment (North 363). Herbert Simon is cited as being the pioneer for consideration of an individual actor’s subjective perception of the world around them, from which one can gain a better understanding of the choices the actor makes, based on the difference between the real world and the perceived world (North 362). It is the limited knowledge and bounded rationality of the actor that inhibits the process of decision making, with decisions often being otherwise unexplainable (North 362). In the study of individual decision making, North emphasizes consideration of the information available to the actor and the imperfect feedback received by the actor, based on choices that were made in the past (362).
To gain further understanding of human behavior, North suggests looking into the process by which humans learn, which could possibly be the key component needed to explain the mental constructs that humans develop to explain and interpret the world around them (362). North proposes the concept of ‘collective learning,’ originally introduced by Friedrich Hayek, in which case learning is believed to be passed down through the generations based on an accumulation of knowledge over time (362). He describes the process of learning as being a function of the way in which a given belief structure filters the information derived from experiences and the different experiences confronting individuals and societies at different times (North 363). An example of this is the subjectivity of perceived value; military technology in medieval Europe, the pursuit and refinement of religious dogma in Rome during and after Constantine, and research for an accurate chronometer to determine longitude at sea during the Age of Exploration are all uniquely perceived as being of high value based on individual preferences and perceptions (North 362). Additionally, North states that institutional analysis should explain path dependence, which has been evident throughout history, but has yet to be fully understood (North 365). According to North, the major issue facing economic performance is the creation of institutions that will alter the benefit-cost ratio in favor of cooperative solutions and it is possible that path dependence is an underlying inhibitor of this creation (Hirsch 220).
The development of a theoretical framework to apply to economic history, in which path dependence is the key to institutional change, is arguably North’s most significant contribution to the field of economic analysis. From this contribution, emerges a new understanding of economic growth, as well as a new interpretation of economic history. North starts out by refuting the idea that variation in growth performance across countries is the result of differing productivity factors and yet this variation cannot be understood without providing explanation for the emergence or non-emergence of growth stimulating institutions. By factoring in technology, population, ideology, politics, and institutions when attempting to understand the long run success or failure of societies, North was able to achieve better results than those that could be attained through the neoclassical approach (Myhrman 193). Today, North continues to be an active member within the field of institutional economics, while also taking the time to focus on his passions and teaching, alongside his wife at their home in Maine (Hirsch 221).

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