What is the role of institutions according to North?

How far does this theory go towards

explaining the contours of world development in the pre-modern growth era?
Maddison (2006) stated that he would characterise the whole period 1000-1820 as protocapitalist.
He believes the transition from pre-modern to modern economic growth took place at around 1820.
This will set the stage for this discussion. Within that period, there were two groups of countries
which were differentiated by their deviation in economic growth. They were the Group A nations,
which included Western Europe, Western Offshoots
1
and Japan, while the rest of the world made up
the Group B nations. The contours of world development in this era, largely shaped by Douglass
Norths theory of institutions, can be categorise into two main subsets which are Gross Domestic
Product (GDP) per capita and population demographics, for the purpose of this essay.
North (1990) defines institutions as the rules of the game in a society or, more formally, are the
humanly devised constraints that shape human action. Institutions exist in every economy, in the
form of either formal or informal constraints, developed to define the choice sets, within which
individuals and organisations make their decisions.
Economic growth is heavily dependent on the productivity of an economy, which in turn is affected
by the costs involved. In the neoclassical world of complete information, the gains of trade are only
negated by the costs of production, also known as the transformation costs. Norths theory of
exchange takes into account the transaction costs, which are the costs of exchange that will also
reduce the benefits of trade. Institutions affect these costs which determine the profitability and
feasibility of economic activities.
The role of the theory of institution is to deal with the issue of cooperation. In the real world of
incomplete information and uncertainty, institutions are devised to create conducive conditions, where
there are incentives and disincentives, to facilitate cooperative behaviour. In order to maximise private
benefit, individuals and organisations will seek to cooperate. As a result, the behaviour of the
community will become predictable and certain, since the behaviour of the community is the sum of
the behaviour of parties within it. In other words, institutions establish a stable structure for economic,
political and social interactions. With increased certainty, and therefore, lower costs of exchange,
gains of trade can be reaped at a higher margin which would foster economic growth.
The diagram below shows the dead-weight loss, represented by Area ABC, in a situation where there
is a price increase in real terms, due to the risks involved, and decrease in quantity traded because of
the uncertainty on the arrival of the goods. This highlights the importance of efficient institutions in
reducing the costs of exchange.






1
According to Maddisons classification, Western Offshores consists of the United States, Canada, Australia
and New Zealand









Private, instead of social, benefits are often the focus when devising such rules, formal institutions in
particular. Coupled with the fact that the relative bargaining power of different parties is a major
determinant of the structure of the rules, it explains the persistence of inefficient institutions, a
distinctive characteristic of Group B nations. It is precisely the form of institutional framework that
determines the path of development a particular economy will take, either towards growth, decline or
stagnation which eventually shaped the contours of world development.
Maddison (2006) noted that Group A nations had their average per capita income grew nearly four
times as fast as the average for the rest of the world.
Nations Annual Average Compound Growth Rate
Average Group A 0.13
Average Group B 0.03
World 0.05
Table 1: Rate of Growth of GDP Per Capita, 1000-1820 A.D.
Different forms of institutions developed in areas like trade, scientific learning and social behaviour
resulted in the divergence of the rate of growth of GDP per capita.
During the 1200s, the Venetian Republic experienced sharp economic growth through institutional
frameworks which promoted merchant capitalism and fostered entrepreneurism. Legal and political
institutions were devised to protect property rights. In addition, the development of accountancy
assisted in enforcing contracts and financial institutions gave access to credit and insurance. These
greatly reduced the uncertainty of transactions and incentivise productive-enhancing activities like
large scale international trade, which led to increased income per capita and economic growth.
Contrastingly, in Morocco, the tribal chiefs found it profitable to protect merchant caravans but they
lack the military might and political structure to devise and enforce property rights. The lack of
development of informal rules into permanent institutional framework to cater for a larger market
forestalled the expansion of any form of credible trade and this halted any increase in GDP per capita
and economic growth.
Institutions of intellectual tolerance played a significant role in Western Europe in setting a
foundation for the educational system which was directed by scientific learning. By 1500, there were
approximately seventy academies and universities of secular learning. The productivity of these
learning centres and their willingness to accept new ideas were amplified after Johannes Gutenberg
first developed printing for Europe in 1455. Techniques in book production were then revolutionised
and, by 1483, productivity had increased by two hundred folds. In addition, European publishing was
competitive and there was a presence of international trade in books which led to easy access to new
D
S
P
2

P
1

Q
1
Q
2

Price
Quantity
A
B
C


ideas to a larger proportion of the population. These factors significantly incentivise the Europeans
towards literacy and education, cultivating creativity and innovation. Although printing was available
five centuries earlier in China than in Europe, the access to new information for the Chinese
population was nothing close to that of the Europeans. China was a centralised state and its
bureaucracy was able to exercise thought control by means of censorship and restriction of books
available to the general population. This difference in intellectual institutions had significant
implications, particularly on knowledge diffusion, which steered the Western Europeans towards
scientific empirical research and experiment, making possible technological process and human
capital development through education; they in turn increased income per capita and economic growth.
Social behaviour was also shaped by the highly contrasting political and religious institutional
framework put in place in different regions of the world in the pre-modern growth era. In Europe,
Christianity was adopted as a state religion as early as 380 AD. This resulted in contrasting
characteristic of marriages, kinship and inheritance, especially that of the Islamic World. The Church
broke down past links to tribes and clans and encouraged individualism and wealth accumulation.
This promoted entrepreneurism which became founding steps towards more productive activities and
exchange, increasing the standard of living in the long-run. On the other hand, Kuran (1996, 2003)
suggested that the ethical and charitable requirements in Islamic law bind potentially productive
resources into unproductive social-service organisations. In this case where redistributive, rather
than productive, behaviour was incentivise, the economy stunted. Such behaviour would allocate
labour resources inefficiently and increase the price of labour in productive sectors, which eventually
led to an increase in transformation costs that would negate the gains of trade. This had adverse effect
on per capita income and economic growth.
Population demographics are another contour of world development. During the pre-modern growth
era, the difference in life expectancy stood out between the Group A and B nations. Maddison (2001)
also pointed out that deviation in life expectancy, as depicted in the following table.
Nations
Average Life Expectation
(years at birth; average for both sexes)
1000 A.D. 1820 A.D.
Average Group A 24 36
Average Group B 24 24
World 24 26
Table 2: Average Life Expectation, 1000-1820 A.D.
Education institutions which facilitate technological advancement in Netherlands, for example,
introduced inventions like water and canal management for agriculture. Additionally, electrical power
generation was made possible by windmills which intensify productivity in the sector. The
improvements, albeit slow, in agriculture increased food availability and led to a decrease in hunger
crises, which were one of the key factors of high mortality before this era. This increase in human
welfare, which in turn helped to lower the mortality rate, contributed to the climb in average life
expectation in the Group A nations by 12 years.
However, the same cannot be said for the Group B nations. The Europeans implemented extractive
institutions in their colonies in Latin America while Africans were forced into slavery. In Asia,
Indias state did little to educate its people to boost the agriculture sector, epitomised by the lack of
use of their sacred cows dung as manure. Coupled with its social institutions like the caste system,
there was little incentive and ability to produce food to curb shortages. Group B nations experienced


little improvements in human welfare, which provides an explanation for the stagnation in life
expectancy.
Cameron and Neal (2003) said that The interrelationship of population, resources, and technology in
the economy is conditioned by social interactions, including values and attitudes. While we cannot
undermine the roles that the other three factors play in shaping the contours of world development, it
is evident, from the examples given throughout the essay, that it is the underlying institutions applied
that determined their growth, utilisation, and eventually, impact on the societies. Cameron and Neal
(2003) summed up the importance of institutions by, coming into agreement with North, suggesting
that institutional change is perhaps the most dynamic source of change in the whole economy. The
sum of the impacts coming from population growth, resources management and technological
advancement, which are heavily influenced by the nations institutional structure, determined the
contours of world development in the pre-modern growth era.
(1484 words)





















References
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The Present. New York: Oxford University Press.
Carden, A. (2007). Christian Ethics, Formal Instiutions, and Economic Growth. American Review of
Political Economy, 34-53.
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Retrieved January 5, 2012, from EH.Net Encyclopedia:
http://eh.net/encyclopedia/article/Harreld.Dutch
Hodgso, G. M. (2006). What are Institutions? Jornal of Economic Issues, Vol. 40, No. 1.
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Proceedings 86(2), 438-442.
Kuran, T. (2003). Why the Middle East is Economically Underdeveloped: Historical Mechanisms of
Institutional Stagnation. Working Paper: Mercatus Center and University of Southern
California.
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Washington, D.C.: The American Enterprise Institute Press.
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(OECD).
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Cambridge University Press.
North, D. C. (1991). Institutions. The Journal of Economic Perspectives, Vol. 5, No.1. , 97-112.