Tadija Tadić

English

Research Papers in Economics

PANECONOMICUS, 2006, 4, str. 487-490                                                                              Prikaz 
 
 
Douglass C. North: Understanding the Process of 
Economic Change (Princeton University Press, 
2005) 
 
Tadija Tadić
* 
 
The New Institutional Economics has been neglected research program of the 
economic theory for a very long time. This is largerly due to most of the 
mainstream neoclassical economists´ dominant view that institutions simply 
“don´t matter“. More recently this view has started to change. With his two 
previous books (Institutions and Institutional Change and Institutional Change 
and Economic Performance), Douglass C. North, a Nobel Prize Winner in 
Economic Sciences in 1993 has in many ways contributed to changing this 
dominant direction and ushered in genuine small revolution in understanding 
institutions. North is now widely acknowledged as one of the economists most 
responsible for a successful story of the New Institutional Economics research 
program over the past two decades. “Institutions matter“ North claims, and in his 
latest book Understanding the Proces of Economic Change (Princeton 
University Press, 2005) goes one step further to offer a radically new theory of 
economic change.  
This new theory is largerly based upon his own insight into the dominant 
role the human intentionality plays in shaping the institutional foundations of 
society and particularly in its capacity for changing circumstances. As North 
says: “[t]he key to understanding the process of change is intentionality of the 
players enacting institutional change and their comprehension of the issues“ /p. 
3/. 
The very source of the human intentionality is, as North argues, the 
ubiquitous effort of humans to reduce the uncertainties of their environment. 
Uncertainty (the term is used in Frank Knight´s sense) and ubiquitous human 
efforts to deal with it and confront it is the first building block of the theoretical 
frame applied in this work.  
In the next step North integrates the cognitive aspect into his analysis and 
tries to give answers to some of the following questions: how people understand 
reality? How do beliefs got formed? Whose belief matters and how does 
individual belief aggregate with belief systems? How do they change? What is 
the relationship between beliefs and institutions? North argues that people 
construct mental models of the outside world – beliefs that are both positive 
                                                 
* tadictadija@neobee.net Prikaz 
  488
models of how the system works and normative models of how it should work. 
But what counts are the beliefs of the dominant economic and political 
entrepreneurs capable of imposing policies. Their beliefs result over time in 
accretion of the fundamental structure of institutions. At the same time the 
structure itself imposes severe constraints on players who seek to improve or 
change their competitive economical or political positions. Thus, the change is 
incremental and path dependent. The final result of this continuing change is the 
alteration of institutional matrix and revisions of players' perception of reality 
which, in effect, spurs new efforts by entrepreneuers to improve their positions. 
In nuce, the process of change can be shown as follows: perceived reality – 
beliefs – institutions – policies – altered perceived reality. 
The first part of the book (named “Issues Involved in Understanding 
Economic Change“) is mainly about elaborating the outlined theoretical frame in 
great depths. Thus, Chapter II deals with the uncertainty in non-ergodic world. 
Following Herbert Simon´s ideas on bounded rationality, North argues that 
uncertainty cannot be eliminated because the nature of human mind is such that 
our knowledge is necessarily partial and incomplete. He also stresses the 
importance of the fact that the world studied by social sciences is essentialy 
“non-ergodic“ – that is, the underlying structure of the human domain shifts as 
human attempt to alter it.  
Chapter III (“Belief System, Culture, and Cognitive Science“) deals with the 
structure of individual beliefs, its logic of change and its aggregation with belief 
system embedded in culture. In order to provide a better understanding of how 
individual beliefs are formed North dvelves deep into cognitive sciences by 
further elaborating recent discussions on how the brain really works. One of his 
major contributions in this book is to align his institutionalist priors with theories 
of connected or embedded cognition. Relying on Hayek´s ideas as expressed in 
The Sensory Order: An Inquiry into the Foundations of Theoretical Psychology, 
North argues that humans think and act within the context of a system of 
categories and assumptions that provides a necessarily incomplete model of the 
world. Further elaborating this intriguing idea, North claims that our institutional 
enviroment supplements and shapes our individual cognition by reducing the 
uncertainties that would otherwise overwhelm our cognitive capacity. According 
to North there is no understanding a society´s structure of interaction 
independently of the “mental models“ or systems of belief that help constitute 
that structure.  
Finally Chapters IV (“The Scaffolds Human Erect“) and V (“Taking Stock“) 
tend to explain the links between beliefs and institutions, the nature of 
institutional change and how performance is affected by institutions. Although 
North, on the trail of his previous works, defines institutions as the formal and 
informal constraints of human interaction and enforcement characteristics of 
both, in this book he significantly advances his conception of the nature of Prikaz 
  489 
institutions by integrating ideas from the cognitive psychology and philosophy 
of mind. 
After the analytical frame has been established, North continues with 
applying it in the second part (titled “The Road Ahead“) to the wide array of 
questions concerning different aspects of economic history from a dawn of 
human evolution to the demise of the Soviet Union. Chapter VII (“The Evolving 
Human Enviroment“) particularly focuses on the past two millennia of change in 
the human landscape. North argues that there are two sorts of institutions – those 
ones constructed to deal with uncertainties of physical environment and those 
constructed to deal with the human environment. North´s central message is that 
there is no economic development until the former is being altered with the 
latter. 
In the next chapter author tries to identify the main sources of order and 
disorder. If the existing institutional matrix provides better predictability in 
human interaction, as argument goes, there will be greater order which implies 
reduction in uncertainties and vice versa. North stresses the importance of the 
“adaptively efficient institutional structure“ /p. 111/ pointing to differences 
between the British Empire´s successful long-term growth and the Spanish 
Empire´s failure. 
After illuminating some historical cases of getting it right and getting it 
wrong in Chapter IX, North in Chapter X (“The Rise of the Western World“) 
tells us a dynamic story of a successful change through time pointing to the 
critical impact of a “competitive decentralized enviroment“ /p. 137/, as 
differentiated from centralized empires, such as those of China and the 
Ottomans. It is worth pointing out that the main line of argumentation in this 
chapter is based on one of his prior classic articles under the same title. 
The eleventh Chapter deals with more contemporary issues, namely, with 
the rise and fall of the Soviet Union indicating what happens in the absence of 
the “adaptive efficiency“ and a flexible institutional structure. 
The ongoing problems of underdevelopment and transition countries is at the 
core of Chapter XII (“Improving Economic Performance“). According to North 
the evolving structure of economic and political markets is the key to improve 
economic performances. But, North warns that “there is no set formula for 
achieving economic development“ /p.165/.  
In the last chapter (“Where are we Going?“), North explores how much we 
can know about the future. On the basis of his own insight into a very limited 
human foresight, the autor suggests more sober appraisal of humans future in the 
face of ubiquitous uncertainty in non-ergodic world. 
The book is a brilliant achievement. This path-breaking work boldly opens 
new frontiers in economic research. One of the striking features is that the author 
bravely distances himself from the economism dominating over the most part of 
economic historians´ analyses. North heavily draws from different disciplines 
such as: cognitive sciences, anthropology, political science, sociology, history Prikaz 
  490 
and economics in order to provide a deeper understanding of the nature of 
institutions. But it doesn´t mean that North abandones the neoclassical 
economics. As he once said: “to dissmiss the neoclassical economics is to 
dissmiss the economics as a science.“ Operating within the New Institutional 
Economics research program he tries to modify the neoclassical theory, to 
extend it, particularly its rationality postulate in order to permit it to come to 
grips with an entire range of issues heretofore beyond its ken. Moreower, in this 
book North sets forth a radical reconceptualization of the task and methods of 
the social sciences in general and economics in particular.  
Anyone who is interested in the research field of the New Institutional 
Economics and in an alternative view of economic history should inevitably read 
this book. 
Douglass C. North is Professor of Economics, Spencer T. Olin Professor in 
Arts and Sciences at Washington University in St. Louis and Bartlett Burnap 
Senior Fellow at the Hoover Institution. Co-recipient of the Nobel Prize in 
Economic Sciences in 1993, he is the author of Structure and Change in 
Economic History and the author, co-author, as well as the editor of seven other 
books including many articles.  
 
  

Book review: Douglass C. North: Understanding the Process of Economic Change (Princeton University Press, 2005)

http://www.panoeconomicus.rs/casopis/cetvrtibroj/understanding%20the%20process%20of%20economic%20change.pdf

Book review: Douglass C. North: Understanding the Process of Economic Change (Princeton University Press, 2005)

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