Institutions and World Economic Development
The Significance of the ‘Rules of the Game’ in Poverty Alleviation
Jul 9, 2009
An important project of the New Institutional Economics (NIE) is to understand and apply its analytical framework to the problems of economic development. Mostly driven by Douglass C North, contributions come also from many other scholars. The basic understandings of the nature of institutions, their role in society, how they are created, how they change, and how this relates to economic development lies at the core of the project.
Underdevelopment and the Persistence of Poverty
Probably the greatest social question of modern times is persistent third world underdevelopment and poverty. It is a question for which definite answers are elusive and policies prescriptions tentative, despite success stories like South Korea and Taiwan. The past decade has seen the rise, failure and fall of the Washington Consensus, but there is no clear alternative to fill the vacuum. The NIE is a promising avenue of research that might have the potential to make a meaningful contribution to the resolution of the problem.
Peter Klein, in an article in the “Encyclopaedia of Law and Economics”, published in 1999 by Edward Elgar and the University of Ghent (pp 456-89), says that it is an interdisciplinary enterprise straddling and combining insights from economics, organization theory, political science, law, sociology and anthropology. Its quest is to explain what institutions are, how they arise, and what purpose they serve. Douglass North in his 1990 book titled “Institutions, Institutional Change and Economic Performance”, published by Cambridge University Press, identifies at p.84 the understanding of change and economic development as its central interest. Although borrowing liberally from various social disciplines, its primary interest is economics.
However, the NIE is part of the larger body of scholarship known as institutional theory. W Richard Scott, who has been aligned with new institutionalism since the mid 1980’s, embraces the broader tradition of institutional theory. His approach is rooted in sociology, not economics. In a 1997 review of Scott in The American Journal of Sociology, Vol. 102, No. 6 (May, 1997) pp. 1702-1723, Paul Hirsch describes him as “organizational sociology’s senior statesman.”
Why Institutions Matter - the Rules of the Game
In order to appreciate the value of any theory an understanding of its key concepts is obviously essential. Many concepts are incorporated into institutional theory, such as transaction costs, path dependence, tastes, information costs, and many others. However, the key concept remains “institutions.”
In his 1995 seminal work, “Institutions and Organizations: Theory and Research”, published by Sage, Scott postulates three basic elements, namely the “cultural cognitive, normative and regulative elements that together with associated activities and resources, provide stability and meaning to social life.”
North again, defines institutions as “the rules of the game in a society, or more formally, (…) the humanly devised constraints that shape human interaction.” He states that institutions “consist of both informal constraints (sanctions, taboos, customs, traditions, and codes of conduct), and formal rules (constitutions, laws, property rights).”
Recognizing the wide disparity of views approaches and assumptions of institutional scholars, and the fact that different theorists tend to privilege one or another class of elements of institutions, Scott developed a new typology incorporating many of the competing definitions. Institutional theory concerns itself, he says, with the deeper and more resilient aspects of social structure and “…considers the processes by which structures, including schemas, rules, norms, and routines become established as authoritative guidelines for social behaviour. It inquires into how these elements are created, diffused, adopted, and adapted over space and time; and how they fall into decline and disuse.”
Scott’s view of institutions as structures, including schemas, rules, norms, and routines that have become established as authoritative guidelines for social behaviour is wholly compatible with North’s view that they are the humanly devised constraints that structure political, economic and social interaction.
The “established authoritative guidelines for social behaviour” in any society clearly shape, prescribe and proscribe the actions of all agents within that society, whether they act politically, economically or socially. Thus institutions matter and understanding the relationship between institutions and economic change and development is crucial.
Developing Institutions for Growth
Economic development is more than mere per capita GNP growth; it means human development. It also means ‘capability development’ as Amartya Sen in 1999 argued so persuasively in “Development as Freedom,” published by Oxford University Press.
Development involves the transformation and creation of institutions, their diffusion, adoption, and adaptation over space and time. When a society changes its mode of production, its organisational structures, its resource employment, and its view of people, there is a concomitant change in its governing institutions. To change the social conditions, the institutions must change. That is the challenge.
North concludes, saying we lack knowledge of cultural norms and how they interact with formal rules: “We are just beginning the serious study of institutions. … We may never have definite answers to all our questions. But we can do better.”
Understanding the institutional context of economic development is at present a promising, but unfinished project. There is much more to do than has been done. An urgent need exists for a theoretical research program of Institutions and Economic Development.
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