book cover imageUnderstanding the Process of Economic Change
by Douglass C. North.
Princeton University Press (Princeton and Oxford), 187 pp., $10.00 cloth, 2005.
Douglass C. North’s new book represents a watershed in the social engineering consciousness. North, who won the Nobel Prize for Economics in 1993, is a social engineer made humbler through the hard experience of the repeated failures of social engineering to improve the economic performance of developing countries. North recognizes that the abstract, mathematical models that developmental economists typically have used are inadequate representations of complex, messy social realities. He acknowledges the importance of hard-to-quantify factors such as belief systems and customs in shaping economic outcomes. He understands that any individual possesses only a tiny fraction of the knowledge that market processes manages to pool from every market participant’s knowledge, and that this relative individual ignorance holds of social planners just as much as of the economic agents they hope to direct.

However, North’s humility, while encouraging, never reaches so deep that he asks if social engineering itself might be a bad idea. He is a chastened social engineer, but only to the extent that he advocates improved engineering techniques. His recommended techniques are more cautious of undermining existing social practices, which might be playing roles in the maintenance of social order of which the planner is unaware, techniques more sensitive to the interrelated character of all aspects of human cultures—a condition that confounds policies based on isolating a handful of ostensibly measurable economic determinants, such as a country’s unemployment rate, its inflation rate, or its trade balance, and then attempting to spur growth by directly adjusting those factors. In fact, the possibility that the disappointing results of previous efforts to aid developing economies may be due more to drawbacks inherent to social engineering itself than to flaws in the specific policies adopted is so far from North’s mind that he considers the suggestion that we simply forego macroeconomic planning to be as fanciful as a proposal that we give up breathing: “But Hayek failed to understand that we have no choice but to undertake social engineering.”

North writes, “The message of this book is that you have to understand the process of economic growth before you can improve performance. . . .” It is certainly true that if one does not understand the process of economic growth then attempts to promote it are shots in the dark, but North never demonstrates that if we do understand the process of economic growth then government will be able to deliberately foster it. He can offer no actual examples of social engineering on the national scale producing good results, and the exemplars of growth he points to, he must admit, have grown “usually without deliberate planning.” The only theoretical counterweight North offers to the empirical evidence is his bald assertion that we simply must engage in social engineering.

Like any good engineer, North needs something to quantitatively measure, and what he has chosen are transaction costs. He asserts that the best gauge of the economic efficiency of a country’s institutional arrangements is the overall level of transaction costs present there. However, he does not offer an adequate explanation of why that factor deserves to be singled out as the focus of our attention. Certainly low transaction costs are nice, but it also would be nice if the cost of any other input into production were lower. Free real estate, free iron, free energy—the condition of their zero cost being that they were available in such abundance that they were no longer scarce—all would be beneficial, enabling us to devote more resources to acquiring other, still scarce factors of production. Furthermore, North ignores the fundamental difference between two distinct routes that policy makers might follow in seeking to reduce transaction costs. One route looks to eliminate unnecessary costs of trading that have been created by governmental interference with the freedom of economics actors. For instance, if there were a law in place requiring any property owner who wished to sell his land to crawl the perimeter of his holdings in the presence of the buyer, the government would be imposing an apparently pointless transaction cost on real estate transactions. On the other hand, if a potential buyer and seller are having difficulty agreeing on a sale price, and the state simply steps in and commands they transact at a price it sets, then the government is short-circuiting an intrinsic part of the market process, namely, participants’ efforts to discover optimal prices.

North’s book also contains several less egregious, but nonetheless significant, misapprehensions regarding its subject matter. Among them is his curious contention that the fundamental goal of human action is to reduce uncertainty, and that advancing that end is the primary raison d’être of social institutions. This contention is especially disheartening because Aristotle offered a more cogent view on the nature of agency about 2400 years ago: A person acts to achieve what he sees as a more satisfactory state of affairs than he believes likely to obtain if he does not so act. Per that view, while an agent’s effort to improve his circumstances could entail reducing uncertainty, it might just as well imply choosing to increase it. For example, if I believe I am certain to die of cancer in the absence of any medical treatment, but I am persuaded by my doctor that I will increase my odds of surviving the disease if I submit to the therapy he recommends, then I am likely to follow his advice, even though it makes my future much less certain. It is also doubtful that sports fans would be happier if the uncertain outcome of the contests they enjoy was lessened by deciding the winner in advance of the event, and, indeed, one of the important functions of many of the institutions that exist to govern various sports is to maintain that uncertainty by outlawing and punishing “fixing.”

Another lacuna in North’s work is that, while he acknowledges that a society’s time-tested traditions may have some value that eludes the models of mathematical economists, he is unable to entertain the idea that traditional religions might perform a vital function in social life. He expects his readers to accede without argument to his contention that humans have an “‘addiction’ [to] ‘non-rational’ explanations [that includes] religions.” The sophisticated philosophical systems developed in, for example, Thomistic Catholicism or Mahayana Buddhism apparently have made no impression on him.

North is also susceptible to the temptation to invoke some fashionable intellectual pursuit despite its superfluity to the point he is making. For instance, discussing the motivations of American revolutionaries, he writes, “British actions provided evidence (in the sense of Bayesian updating) in favor of [their] ideas.” But “Bayesian updating” does not describe some particular type of evidence; it is a theoretical model of how any sort of evidence whatsoever ought to affect beliefs. To mention it in an explanation of why the American founders, who were unlikely to be unacquainted with the ideas of Bayes, opted for US independence, appears to be motivated merely by the fact that Bayesianism is currently in vogue. Similarly, he cites neuroscience, another trendy discipline, in discussing the impact of culture on human action, quoting the cognitive scientist Merlin Donald, who claims: “Culture can literally reconfigure the use patterns of the brain, and . . . those patterns of use determine much about how the exceptionally plastic human nervous system is ultimately organized, in terms of cognitive structure.” Whether or not Donald is correct is extraneous to North’s case that culture significantly influences behavior. That truth was recognized long ago, for example, by Plato, who was quite ignorant of modern neuroscience. North’s argument here only requires that culture is important to understanding people’s decisions, regardless of the way it does so.

None of the above criticisms negate the fact that North’s work represents a major advance in the mainstream of developmental economics. His critical examination of the shortcomings inherent in the sort of mathematical modeling that had previously dominated the discipline, especially coming from such a prominent source, alone makes his book worth reading. Understanding the Process of Economic Change is notable, both because of the many genuine insights it offers and because it signifies an important shift in the attitude of developmental economists. But it is ultimately unsatisfactory, due to its failure to address the most fundamental question about its topic, which is, “Is the attempt to implement the designs of rationalist ‘experts’ a promising method for improving upon spontaneously evolved, traditional social arrangements?”
Gene Callahan is a doctoral candidate in the Department of European Studies at Cardiff University, and the author of the book Economics for Real People and the recently published novel PUCK. He is an adjunct scholar at the Ludwig von Mises Institute and a charter member of the Michael Oakeshott Association.