Douglass North: How Did We Even Get Here?

The iPhone X just came out yesterday. This phone costs $999, has insane processing power, and has facial recognition that can be used to unlock the phone and make purchases. Technofears and privacy debates aside, this is a marvel of technology. I promise this isn’t an Apple commercial, I’m just taking a moment to be astounded at how far we’ve come today.

This would have been witchcraft 100 years ago.

How on earth did we get where we are today? For most of human history, we barely got by, living only on what we could make alone. Then, a spark of growth. A scattering of huts surrounding farmland grew into tall buildings, constantly pushing the limit as to just how high they’d go up into the sky. The oldest person alive today has seen the world grow from a largely horse and buggy society with limited electricity to a world with rocket ships, robots, and driverless cars.

What created this growth? Technology, sure, but what led to this explosion of technology? Institutions is another good answer, but what creates these institutions?

Douglass North asked these questions and began the search for answers to them. His findings helped him win the Nobel Prize in Economics in 1993. The prize was awarded to both North and fellow economist Robert Fogel for “having renewed research in economic history by applying economic theory and quantitative methods in order to explain economic and institutional change”

Taken from nobelprize.org

What does North have to say about how we created the institutions that spurred such growth? In his paper, Economic Performance Through Time, North begins an answer to this. He says that the development of institutions is a relationship between informal norms and formal rules. He also says that informal norms give legitimacy to the formal rules.

Let’s unpack those statements a bit. What does North mean by informal norms? I’ll start with a trivial everyday example. When you go through a door, why do you hold it if someone’s walking behind you? Have you become irrationally (perhaps rationally, to you) angry when someone doesn’t hold it for you when you’re literally right behind them? You might say that it’s just being polite, but even the idea of what constitutes “politeness” is an informal norm.

Yeah, you better hold that door for me, James!

Formal rules can be changed instantaneously, all it takes is a majority of the swamp to sign a bill. I know that those who have any experience in government are saying that it’s not as easy as I’m making it sound. However, compared to informal norms, which can take up to an entire generation to change, the session in congress it takes to change a rule is a blink of the eye.

With the time it takes informal norms to change, sometimes we have a disconnect between the formal rules and the informal norms meant to give them legitimacy. This leads to institutions failing in some areas while succeeding in others. We can see this in hostile changes of leadership.

When the Gaddafi and the Libyan regime was toppled, the international community at large had a hand in it. They performed air strikes and prevented the regime from performing any of its own on the resistance. However, when a new regime and rules began to form, we found that the previous ideas of leadership began to arise once again. The liberated Libya quickly fell into conflict again.

Why did this happen? The different militias that had been unified against Gaddafi began to fight each other. They had this perceived idea of how leadership in Libya should be, based on their own experiences. This norm of governance led to them all wanting to be the group in power and refusing to allow others take power.

So, what’s the point? When looking at a country’s development, we rightfully assume that the institutions in place can make any money we give less effective. If a country has corrupt officials, money often ends up lining their pockets instead of going to those in need of he aid. However, the next step in peoples’ minds is to make the governments change their institutions in exchange for aid. These institutions have a very high tendency to fail.

Here’s why: If there’s corruption in the government and we create a formal rule to crackdown on corruption, we haven’t really changed the informal norms of corruption yet. People in these countries have a general idea that they should pay or be paid to transfer money and goods through customs. Even when the rules themselves change, peoples norms take much more time to do so.

So, I jumped between three different examples that use the ideas from just one paper written by Douglass North. His works on building institutions can be used to examine and explain so much more about international development and economic history. He empowered economists to have an additional tool at their disposal to try and understand how countries like Libya tend to follow the same path, how institutions that succeed in the US fail in other places, and most importantly, how we’ve gotten where we are today.

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