CATO JOURNAL Understanding the Process of Economic Change Douglass…

CATO JOURNAL




Understanding the Process of Economic Change
Douglass C. North
Princeton: Princeton University Press, 2005, 187 pp.
  You may know the joke about the chemist, the physicist, and the
economist in a lifeboat lost at sea with a single can of food and no way to

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open it. When the punch line arrives, and the economist suggests, "As-
sume a can opener!" the joke is on the scientific and practical pretensions
of economics. And indeed, some of the "simplifying" assumptions of
economic theory--such as perfect information; zero transaction and en-
forcement costs; and automatic, instantaneous, and veridical updating of
beliefs--undercut its ability to explain, for example, why Canada is fabu-
lously wealthy while Zimbabwe is not. In Understanding the Process of
Economic Change, Douglass C. North--co-winner of the 1993 Nobel
Prize in economics and dean of the New Institutionalist school of eco-
nomics--sets forth a radical reconceptualization of the task and methods
of the social sciences in general and economics in particular, providing a
glimpse at an economics that refuses to "assume a can opener." The
result is either exhilarating or vexing, depending on one's prior method-
ological commitments.
   Understanding the Process of Economic Change proceeds in two sec-
tions. In the first section, North raises a number of methodological issues,
including the nature of uncertainty and unpredictability (Chap. 2), the
integration of the cognitive sciences into economics (Chaps. 3 and 4), and
the way taking the mind seriously changes how we must conceive of
economic and political institutions (Chaps. 5 and 6). In the second sec-
tion, North attempts to illustrate how such an ambitious program might
be put to use to aid our understanding of economic change. Here North
dons his historian's cap, and discusses the way in which humans have
altered their environment throughout history (Chap. 7), provides up-
dated accounts of the rise of the western world (Chap. 10), and the rise
and the fall of the Soviet Union (Chap. 11), preceded by reflections on
the institutional sources of order and disorder (Chap. 8), what it means
to get institutions "right" (Chap. 9), and topped off with an examination
of the lessons for promoting economic growth in the present day (Chap.
12).
   Others are better equipped to comment on whether North's contri-
bution in the historical chapters marks an advance on previous scholar-
ship in economic history. I will concentrate on the first, more method-
ological, section of the book, and the chapters on economics and the
mind in particular, in an attempt to comment on the direction in which
North aims to take economics and the social sciences.
   At the outset North argues that an adequate theory of economic
change will not consist of an abstract model that professes to predict the
future given a complete specification of the past, or which claims the
ability to determine with certainty how a change to the rules of human
interaction will ramify through society. Rather, an adequate theory will
range over anthropology, history, demography, and psychology as well as
economics, and will be unavoidably unwieldy, even if we aspire to some
kind of "consilience."
   North argues that human institutions are motivated in large part by a
drive to reduce or manage uncertainty (North uses the term in Frank
Knight's sense). But uncertainty cannot be eliminated; the nature of the

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human mind is such that our knowledge is necessarily partial and incom-
plete. North also stresses that the domain studied by the social sciences
is "non-ergodic"--that is, the underlying structure of the human domain
shifts (in perhaps unintended ways) as humans attempt to alter it. And as
we alter it, it changes how we represent the costs and choices we face,
which in turn changes how we attempt to further alter our institutional
environment. And so on. The explananda of the social sciences are mov-
ing targets.
   In the tradition of his previous work, North continues to define insti-
tutions as the formal and informal constraints on human interaction, the
"rules of the game." And he continues to argue that economic perfor-
mance is a question of the quality of a society's political and economic
institutions. However, in Understanding, North has significantly ad-
vanced his conception of the nature of institutions by integrating ideas
from the philosophy of mind and the cognitive sciences.
   Following F. A. Hayek, North stresses the fact humans think and act
within the context of a system of categories and assumptions that pro-
vides a necessarily incomplete model of the world. We do not represent
to ourselves the full range of possible actions. And our estimation of the
relative costs of our alternatives depends on how we represent them,
which depends on our underlying system of beliefs. There is no under-
standing a society's structure of interaction independently of the "mental
models" or systems of belief that help constitute that structure.
   North is particularly fascinated by the hypothesis that religious belief
plays a central psychological role in human belief systems--the role of
bringing a sense of order to otherwise unmanageable uncertainty--and
that these beliefs will tend to have important effects on the way people
represent alternatives and costs. In recent lectures, North has repeatedly
argued that we cannot truly understand economic change until we can
understand what can drive a group of well-educated, middle-class Mus-
lim men to fly planes into the World Trade Center. Here, less dramati-
cally, he promotes as a model Avner Greif's work on the way individualist
and collectivist belief systems played out in the economic activity of
medieval Genoese and Muslim-influenced Maghribi traders, and stresses
the role of ideology in the expansion and demise of the Soviet Union.
   North wants us to understand that although orthodox rational choice
assumptions are fine in their place (their place is "competitive posted-
price markets") the general "game" of responding to incentives is his-
torically and culturally conditioned. He refers admiringly to the work of
a team of anthropologists and economists who have conducted experi-
mental economic games in a wide variety of cultural conditions and have
found that performance in those games varies systematically with cultural
variables. The implication is that an understanding of the cultural back-
ground of economic interaction is necessary "if we are to account for the
wide and still-widening gap between rich and poor countries" (p. 47).
   In his citation of these cross-cultural experiments, North seems to
endorse the idea that preferences are shaped by the existing institutional

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structure, and are not exogenous, or independently fixed, as orthodox
modes of economic and policy analysis assume. This should be enough to
make any classically trained economist uneasy. North, however, does not
stop there, but flirts seriously with the idea that learning rules and com-
putational processes--much of cognition itself--is endogenous to insti-
tutional structure.
   In "Belief Systems, Culture and Cognitive Science" (Chap. 3), North
allies himself strongly with models of "embedded" cognition. Drawing on
the work of Andy Clark, Ed Hutchins, and Merlin Donald, North com-
mits himself to the view that cognition is not simply something that takes
place "inside the head," but which is done in interaction with a structured
external human environment. Calculators, pens, mathematical symbol
systems, the rules of first-order logic, books, Google, street signs, and so
forth are not mere external aids to an otherwise self-sufficient cognitive
process. Rather, our interaction and integration with these bits of tech-
nology are internal to the process of cognition. As North puts it, "much
of rational choice is not so much individual cogitation as the embedded-
ness of the thought process in the larger social and institutional context"
(p. 25). That is to say, rationality, as the economist traditionally under-
stands it, is not a fixed human universal, but is itself a cultural, techno-
logical, and economic achievement requiring a social-scientific explana-
tion.
   Although he does not deny that the basic architecture of the human
mind is structured by evolution, and that there are thus hard constraints
on the malleability of human preferences and cognition (and thus a solid
place to stand when constructing social-scientific explanations), North
tends to side with "empiricist" connectionist models of the mind and
eschew the "rationalist" or thoroughly nativist model of the mind implied
in the evolutionary psychology of thinkers such as Steven Pinker.
   The implications for the endogeneity of preference and cognition are
so radical that one is led to wonder whether North himself has fully
integrated the implications of his positions in the philosophy of mind, or
fully accepts them. The question is especially pertinent given that the
later historical chapters on the rise of the West and the trajectory of the
Soviet Union, although characterized by an unusually deep appreciation
for the role of belief systems in structuring incentives, otherwise seem
like conventional neo-institutionalist economic histories.
   For example, in Chapter 10, North briefly contemplates the idea that
Christian religious doctrine in the Middle Ages at once (a) enabled a
learning process amenable to economic development and (b) evolved in
response to institutional incentives to provide ever-deeper justification
for the project of increasing the stock of human knowledge, gaining
command of nature, and increasing wealth. However, North's discussion
is merely suggestive, and does not dwell on the possible mechanisms
hinted at in early chapters by which belief systems, preferences, institu-
tional structures, technologies, and cognitive processes might interde-
pendently evolve.

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   Understanding the Process of Economic Change is more a clarion call,
announcing the opening of a new frontier, than the concluding drum-
beats of a research program fulfilled. Should we stop assuming can open-
ers, and wander with North into the tangled woods of interdisciplinary
social science research? To some economists it may seem as though
North is asking us to open the can with a fistful of seaweed. After all,
assumed can openers at least open cans "in theory." However, the real-
world problems of poverty and economic development, for example, have
not proved particularly tractable to theoretical can openers. It is best to
see North's new book as an inspiring reinvigoration of the research pro-
gram of Smith, Hume, and Hayek--what used to be called "the moral
sciences." Whatever one thinks of North's particular attempt to marry
cognitive science, anthropology, political science, history, and economics,
he deserves our admiration for having the vision and courage to go first,
and our amazement for getting so much right.
                                                             Will Wilkinson
                                                              Cato Institute




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