Douglass C. North’s Legacy
Buenos Aires Herald, December 1, 2015
The contributions of the economist and Nobel Prize winner Douglass C. North — who passed away on November 23 — could not be more important for the difficult times that lay ahead for Latin America now that the commodity boom has ended.
North’s research emphasized the importance of institutions to explain the development and strengthening of markets. As market failures occur regularly, designing an institutional setting conducive to promoting competition is the only viable alternative to the powerful push for the nationalization of economic activities. The consequence of unregulated and badly-regulated markets is often the emergence of populist politicians who claim that a state planned-economy will produce better results.
Trained as an economic historian, North made important contributions in the study of the effect of institutions on markets. Together with Ronald Coase, North is widely considered one of the founders of new institutional economics, a field that focuses on the roles of institutions and societal norms in influencing market behaviour.
For North, those roles are central to understanding why healthy markets develop in some countries and contexts and fail to appear in others. As a result, institutional design becomes a central component to explain development. Badly-designed institutions will hinder development just as institutions that correctly align people’s incentives with the larger goals of society will help countries develop faster.
In a field that has been historically dominated by right-wing intellectuals, North represented a breath of fresh air. For North, in order for markets to work well, an institutional design conducive to those objectives, i.e. people’s incentives and societal goals, was necessary. Moreover, because institutional design must also take into consideration the culture and belief systems of each society, there will be different institutions emerging in different places. As one size does not fit all, institutional design must incorporate features that are sensitive to cultural and local values.
Since institutions are sets of rules and norms that regulate markets, North was well-aware of the costs — transaction costs — associated with excessive institutional developments. Institutions are supposed to facilitate sound functioning of markets, not hinder it.
Because left-wing intellectuals would see North as an advocate of regulatory frameworks, and right-wing free market-friendly advocates normally emphasized his mistrust of excessive regulations, the contributions of the late economist were widely used in the ideological struggle over the range and scope of the regulatory power of the government. A less ideologically-charged reading of North would see him as a pragmatist interested in the smooth functioning of markets necessary for bringing about more development.
His historical work on how modern capitalism emerged — including the co-authored book Violence and Social Orders: A Conceptual Framework for Interpreting Recorded Human History (2009) — have inspired many in-depth studies on what allows some countries to achieve an equilibrium of institutions that are both conducive to economic development and to greater inclusion. In short, for North, societies are more successful when they have established markets that facilitate interactions and build institutions that will prevent societies from degrading to a natural state of violence.
As the author of a chapter in a book that applied his theory to developing nations (In the Shadow of Violence: Politics, Economics, and the Problems of Development, 2012), I had the privilege to meet North and discuss issues of development in Chile (the topic of my chapter) and Latin America in general. At the time, North was especially concerned with the negative external variables the commodity boom would have on the long-term stability and development of the region.
As in a movie that we have already seen and does not end well, North believed that Latin American countries were financing higher levels of social inclusion on the temporary income produced by the commodities boom. North feared that at the end of the boom — something that, as history has taught us, was bound to happen eventually — the pressures for social inclusion would result in testing times for a region that has historically lacked strong institutions.
North remarked that countries had strong institutions when the presidency was more important than the president. That rule of thumb proves particularly predictive of strong and weak democracies in Latin America. North also emphasized the need to put in place sustainable mechanisms to promote social inclusion. He was concerned about the ability of Latin American governments to promote competition and strengthen markets rather than resort to the old tradition of protecting special interests and promoting state-owned companies.
Having lived a full life, and with an impressive legacy of books, articles and disciples, North passed away at the age of 95. Up to the end, he was still active in applying his model of Social Orders to developing countries. As a scholar who valued institutions over personal leadership, North would have probably wanted the field of New Institutional Economics to continue making intellectual progress after his passing.
Those who have read and learned from him will miss his wisdom and intellectual rigour. New Institutional Economics will continue to make contributions to understanding modern societies but now, as in other successful intellectual disciplines, the field will also have a larger-than-life figure to inspire future research.